Penny stocks are stocks that cost $5 or less and are traded outside of the main markets, including AMEX, NYSE and NASDAQ. Because they are handled independently and are low-priced, penny stocks are a great way for inexperienced investors to get a handle of the market and to understand the inner workings of the trading counters.
Contact a broker if you want advice on how to get started but don’t expect a professional to take over a portfolio based only on penny stocks. Because the potential for profit is small unless you’re willing to invest large amounts of money, a broker is unlikely to be interested. Once you learn the basics, however, you should be able to trade over the internet or phone without the need for a middleman.
Keep in mind that penny stocks are considered high-risk investments. They are more likely than any other type of stock to lose value over a long period of time, but equally likely to double or triple their value. Because penny stocks usually belong to new and unsecured companies, they are also less likely to have a backing and a confirmed liquidity.
Find out where your local over-the-counter (OTC) market is situated. Since penny stocks are not traded through the stock exchange market but instead through side exchange sites, you will need to locate a direct contact. The NASDAQ National Market is a good example of a site dealing with penny stocks.
Learn the “bid and ask” price connection. Penny stocks are sold not by single unit price but by estimated values. When you buy a penny stock, you pay the ask price, which is what the seller considers a fair value for the stock. This is not necessarily the real value of the stock and, in fact, is usually inflated by at least 25 percent. The difference between the bid (real) and ask (selling) price is called a spread and is the base in which you will calculate your earnings.
Use a broker if you’re planning on buying stocks in sets of 100. These are sold by people known as market makers, who are in charge of handling penny stocks and organizing their sale in a way similar to an auction. Since you are only committed to buying 100 stocks, you can always choose to back out if prices on subsequent sets get too high for comfort.
Because investment is low and the risk high, penny stocks have been often labeled as nothing more than a beginner’s game. Done well, however, and in quantities large enough to make a difference, you can still earn and show a profit. Penny stocks are usually from companies that are either new or expanding. Don’t expect well-known names.