Are Penny Stocks Worth It?

Are Penny Stocks Worth It?

If you're not interested in the traditional model for stock trading, there's another avenue that could be ideal for you: penny stock trading. Penny stocker traders, or day traders as they're often called, have earned a reputation as risk takers.

Day trading is a method of making money on the stock market, but it bucks the tried-and-true method of diversifying and buying into safe stocks that trade for more than $100 per share. You don't aim for a 15 to 30 percent annual profit – you're looking to increase your investment two- or three-fold within a day, week or month by purchasing stocks that aren't even listed on major stock exchanges.

To say that penny stocks, or microcaps, aren't worth your time isn't fair. Many financial experts say you're more likely to lose money if you play the penny stock game, and they tout patience as the way to fortune. Those who have made money on the market using one of the many day trading methods, though, say it works for them – and they have the lifestyle to prove it.

How It Works

Penny stocks are traded under the radar. Most investors are looking at the bigger stocks that scroll across the ticker that are obviously good buys, like Johnson & Johnson, Apple, Disney and pharmaceutical companies. These stocks generally trade at $100 or more. Penny stocks generally trade at $5 per share or less and they have low trading volumes.

If you buy enough shares and follow a stock's momentum – up or down – you can make a profit off a single trade, in percentage points, anyway. And that's what day traders are banking on.

Day Trading Strategies

When you choose a strategy, you should stick to it. Learn everything you can about one method, so you know you can turn a profit or cut your losses early. Penny stock trading strategies include momentum trading, bull flag trading and breakout trading, to name a few.

In momentum trading, you keep an eye out for a stock that suddenly starts moving. You follow the trend and the news. You can identify a gapper, or a stock that opens with a price gap, within the first hour of the market opening. If its price rises above the amount it closed at the day before, you buy.

Be aware of bull or bear flag indicators, so you know when to buy or sell. A bull flag pattern starts with a sharp increase in a stock's price followed by a fall when some investors get out. If you're correct when identifying the pattern, you can ride out the rises and falls all the way to the top. Generally, though, most day traders won't hold a stock more than a couple of days.

Breakout trading involves studying a stock's support and resistance levels, which are the highs and lows of a stock's price position. When a stock slides out of either barrier is when breakout traders swoop in. Once you've held the stock for as long as you're willing, you have to plan an exit strategy by predicting which way the stock is going to go. You may have to settle for a loss.

What's the Risk?

There's always the chance that you won't be able to unload the stock you purchase. That's one reason why penny stocks are so risky. Another reason is that you're working with a limited amount of stock and trading off the major markets – the market is smaller. So, you're likely trading with insiders who may have more knowledge of a company or stock than you do. You risk betting on a stock of a company that's bound for bankruptcy.

Trading penny stocks is always a risky endeavor because of the lack of information available about a company, and the price of a penny stock can change in seconds. You must trust your intuition and follow a strict set of rules you create for yourself. Even the most successful day trader must keep their ego in check – it's hard to determine that you're winning because of skill or luck.

There's also the risk of fraud. Be aware of email scammers that try to entice you into buying artificially inflated stocks to increase the odds of other traders buying into the stock, only to have the insider traders bail when the price is high, leaving you with worthless stock – also known as a pump-and-dump scam.

Is It Worth the Risk?

Whether penny stocks are worth the risk to you is a question you should answer for yourself. An extreme amount of stress comes with day trading, and you have to brace yourself psychologically for both big wins and losses. You're working with a limited amount of information, actively looking out for fraudulent schemes and following patterns that could work for or against you.

Most financial experts warn against penny stocks but acknowledge there's a lot of money to be made in a volatile smaller market. There's also a lot of money to be lost.

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