What Are Penny Stocks and How Do They Work?

What are penny stocks and how do they work - penniesMany novice traders are scared of investing in penny stocks. This fear is often fanned by past failures and a lack of understanding on how penny stock markets actually work. Of the many inexperienced investors who take the  plunge into penny stock trading, only a small percentage have the knowledge  needed to succeed in this kind of a trade.

So, what do successful penny traders know that inexperienced traders have no clue about?

An overview of penny stocks

Typically, penny stocks are share prices for small companies which are yet to gain a foothold in the market. These may include mining companies, startups, small technology ventures and any other company whose shares trade at prices below the $ 1 mark.

How do they work?

When a small business is starting up, they often have limited resources. These microcap companies sell their shares at a much lower price in order to get capital to pump into the businesses. These are the shares known as penny stocks.

Speculative investors buy such shares in large volumes with the hope they will gain in value as the company grows. If the business does indeed grow, the shares increase in value resulting to substantial profits for the investors. They may also lead to losses if the business fails to impress in the market.

Let’s check out some tips and strategies that you might need when investing in penny stocks.

  1. Start with minimal capital

    Just as with any other business, there is a chance you may lose a part of your capital in the early stages of the investment. Besides lacking the necessary experience, you may not have control over your emotions or ‘greed’ for big bucks leading to making  risky decisions that lead to losses.

    By investing only a fraction of your capital and striving to grow it, you will give yourself a chance to experiment on the different fronts of penny stock trading without risking going bankrupt.

  2. Avoid thinly traded or free stocks

    The fact is penny stocks are among the few market derivatives or company shares that are hardly in the limelight. Scammers and shady characters see this lack of exposure as an opportunity to steal from inexperienced but avaricious traders looking to grow their wealth overnight.

    Scammers often use free stocks as bait by promising such traders of huge returns out of their meager capital investments. If you’d like to secure your investments, avoid free stocks as they may be a ploy to scam you. Free things tend to be very expensive in the long run.

  3. Research and have realistic profit expectations

    Understanding the company that you are about to invest in is just as important as having an investment strategy. It takes effort, research, and patience to uncover those penny stocks that will give you a good return on investment.

    It’s only through research that you can actually understand how penny stocks work, the dangers of trading in penny stocks and how you can protect your investments. A well informed trader see penny stocks as an opportunity to grow their wealth over time rather than a scheme to get rich overnight. They thus have realistic profit expectations.

    In all honesty, every business you get into will not give you profits overnight. There is usually a learning curve that you need to go through before success comes knocking at your door.

  4. Spread your risks

    A good penny trader diversifies their investment portfolio to minimize the risk of losing all capital in case one trade results in a loss. By spreading the risks, the traders also gain a better understanding of penny stock trading since they have multiple stocks to follow.

  5. Invest in stocks that have a high volume

    Penny stocks that have a high volume of trade are an indicator that there are many willing buyers and sellers in the market. You can, thus, dispose of your shares at any time or increase your portfolio whenever you need to. Stocks with a lower trading volume may hard to dispose as buyers are limited and even skeptical of the low trade volume.

There is no perfect business and  penny stock trading is no exception. Le’ts take a look at the pluses and minuses of these business model.

Here is what in my opinion I think is great about investing in penny stocks

  1. Easy to start trading in penny stocks

    You don’t need to pump in a lot of capital to buy given volume of shares as compared to buying shares for bigger companies. Anyone with a passion for the business can get rolling with a minimal investment.

  2. The learning experience 

    The fact the businesses selling up penny stocks aren’t yet established in the market means you will need to develop the necessary skills to make a profit. These skills will come in handy when you finally decide to jump ship and trade on stock exchanges.

  3. Trading the shares as mid cap stocks

    If the business is registering a marked growth in the market, the share values rises such that it can be traded as mid cap stock in the stock market. The rise in value yields profits for the owner.

  4. Potential to make huge profits

    Once you learn the game, you stand to gain significant profits within a short duration. The value of shares multiplies many times over as the business continues to grow.

Here is why I think penny stock trading might not be the coolest kid on the block.

  1. A risky market

    Penny stocks are often traded where no strict requirements, reporting regulations, and listing fees are required. Because of their low calibers, these markets attract low quality companies whose stock may not actually appreciate with time. Most traders thus suffer losses out of investing in such stock.

  2. Unrealistic valuations

    It’s not uncommon for buyers to be duped into investing in certain penny stocks and driving the prices up. Often times, sellers expose the given penny stocks on media and the public eye leading to massive buy outs. This hikes the prices up before a tumble that sinks many investors capital.

  3. Highly volatile

    Volatility can yield two different results. It can lead to increase in valuation thus earning investors huge profits. Stocks could also diminish in shares leading to massive losses.

  4. Penny stocks are thinly traded

    In contrast to trading of shares on stock exchanges, penny stocks are thinly traded. This makes it hard for investors to invest huge sums of money or move large volumes of their stocks.

Bottom line

For an experienced trader, penny stocks offer an opportunity window to grow a small amount of capital to a sizable amount of money through informed investment and diversification. Even then, it takes time to master the trade and actually become a proficient trader who can see opportunities in the midst of the many, low value shares on offer on penny stock markets.

If you have the passion for this kind of business, by all means go for it. I believe you are better of pursuing  something you love than spending the best years of your life working for a someone else.

People have different interests an passion in life. I am a graphic designer by profession. Maybe you are in a different field of career. Check out this online education platform that has helped me turn my passion into a successful online business.

Many thanks for reading my post. If you have a question or a comment on penny stocks, please leave it below. I would love to hear from you.



Hi there. Great to connect with you. I worked as a graphic designer for many years but could not seem to make much headway. A few years ago I discovered internet marketing and that is how this blog was born. Hazina is a Swahili word which means treasure. It’s what we do here. We help people just like you find their own online treasure. Check out this amazing community based online education program that has helped me build a successful online business and how you too can have a piece of the action.

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