Penny stocks are the source of some of the biggest FOMO (fear of missing out) regrets. Who would not have wanted to have invested $100 in Netflix when it was trading for $1 in 2003. The stock cracked $5 a decade ago. Today, after several stock splits, those 100 shares would be worth over $30,000.
The opportunity to support an early-stage media or biotech company is one of the many reasons investors are excited about penny stocks. Because penny stocks trade for a few dollars, and many for less than a dollar, the upside potential is huge. More pre-IPO companies, meanwhile, are trading up in the private market before they go public, shrinking the potential post-IPO gains. Penny stocks sell shares for less than $5 in companies that could be an Amazon one day.
What are Penny Stocks?
Penny stocks are stocks with a market capitalization of less than $300 million. These small caps typically trade for less than $5 a share. They are categorized as:
Microcap stocks – Stocks that have market caps between $50 and $300 million
Nanocap stocks – Stocks with market caps of less than $50 million
Many trade over-the-counter (OTC) but they may also trade on an exchange. You may also see penny stocks defined as:
- Small cap companies
- Stocks with a maximum price under $5 (Schwab), under $3 (Fidelity) or under $1 (Robinhood)
Why Invest in Penny Stocks?
Because penny stocks are cheap to buy, they provide a low risk-high reward investment opportunity.
Cheap stocks offer the chance to fulfill the investor mantra: buy low, sell high.
- Cheap to buy at less than $5 per share
- High capital appreciation potential
But also introduce many risks, including the possibility that you will not be able to sell the stock at all in an illiquid market.
- Minimal reported information
- Low liquidity
- High price volatility
- Wide bid-ask spreads
- High trading costs
- High probability of company failure
- Dark pool trading with masked prices and volume
How to Choose a Penny Stock Broker?
The challenge is, how to pick the few diamonds in the rough. Over 10,000 OTC stocks are listed, and many of them are penny stocks. Thousands more small cap issues are listed on major exchanges. The failure of small cap companies is high. While shopping for a penny stock broker, you can reduce risk by seeking the following features.
Regulated broker – Brokers must register with the Financial Industry Regulatory Authority (FINRA) to trade stocks on OTC markets.
Regulated OTC markets – OTCBB and OTC Markets boards are regulated, pricing is transparent and reporting and trading infractions publicly reported.
Choice of penny stocks – A large number of penny stocks makes it easier to develop a diversified portfolio. More importantly, the penny stocks should have good liquidity.
Transparency – Alternative trading systems (ATS), also known as dark pools, hide stock price and trading volume. These can be risky, murky places for beginner traders.
Fees – Low fees are more important when buying penny stocks. On cheap stocks, fees and commissions can easily eat away at your investment gains.
Penny stock surcharges – Some brokers will charge an extra fee to trade penny stocks.
How to Research a Penny Stock
Stock profiles provided by online brokers and investment sites (Yahoo, CBSMarketWatch, Bloomberg) are an important research tool for the DIY investor. Unfortunately, penny stocks are not widely covered by these investment sites or analysts. Other research sources exist. One of the most helpful is OTCBB.com, which has filled the void on penny stock info. Here are ways to research penny stocks.
OTCBB – Go to OTCBB.com and click on the Directories page. Enter the symbol you want to research, or view a list of all OTCBB securities and click on the company you want to research.
FINRA – OTCBB operator FINRA provides key data on OTC stocks. Check out:
Trading Halts – Discover if a trade is subject to a ‘Halt’ or ‘Trade Resume.’
Market Statistics – Here, you will find data on the Top 100 Issues, Most Active By Share Volume, Gainers, Losers, and so on.
Short Interest Data – The number of stocks shorted is an important indication of market sentiment towards a stock. If there is a high number of short positions, the market sentiment is negative.
Online brokers – Some online brokers will provide stock profile pages for OTC stocks. The information is typically sparse compared to that provided for an exchange-traded stock, and may be limited to basic trading data. No credit ratings or analyst coverage will be available.
Company information – It is in the best interest of companies to take steps to communicate with investors, even if they are not required to file detailed financial reports. A company may voluntarily file additional information in financial reports, be audited on a regular basis, or have independent analysts provide reviews. A company planning a big board listing will accelerate steps to comply with exchange-listed stock requirements.
How to Buy Penny Stocks
Many of the most popular online stock brokers offer penny stock trading. In addition to exchange-listed small cap stocks, brokers like Fidelity, Charles Schwab, TD Ameritrade, and Interactive Brokers provide access to OTC trading. Brokers that provide access to thousands of stocks across major exchanges will have the widest selection of small caps.
We chose Charles Schwab and Interactive Brokers as the best penny stock brokers because both offer access to a large universe of exchange-listed small-to-large cap stocks, as well as access to the major OTC markets.
Best UK Penny Stock Broker for 2019 – Interactive Brokers:
- What is Interactive Brokers?
- Buy penny stocks on Interactive Brokers
- Invest in Penny Stocks With Interactive Brokers
Fees: $1 per share
Min Deposit: $10,000
Interactive Brokers is a full service online broker with low discount broker fees. The trading fee is low, starting at $1 per share, which is important if you are buying penny stocks in small volumes. Choose between a tiered or fixed rate plan. The fixed rate trading fee is 0.005 per share with a minimum of $1. IB SmartRouting ensures the best execution, meaning you are more likely to get the price you asked for.
Margin requirements: Interactive Brokers has low stock borrowing financing fees, ranging from 3.90 percent (under $25k) to 3.02 percent ($3.5M). Stocks trading below $5 on an exchange are subject to the same margin requirements and fees as other exchange-traded stocks (Long positions: 30% or $2,000, whichever is greater. Short positions: $2.50 per share or 100% of the stock value, whichever is greater.) OTC stocks, including delisted exchange stocks, are not considered marginable and thus require a 100 percent margin to trade. However, Interactive provides access to ATSs like ArcaEdge, which may allow margin trading.
- Low trading fees
- Large universe of OTC stocks to trade
- Access to major OTC markets, including ATSs
In addition to small cap listed stocks, Interactive Brokers provides access to the following OTC markets:
OTC Markets Pink (PINK) – Access thousands of stocks trading on the Pink Sheets.
ATSs – ArcaEdge. IB also allows traders to trade directly over-the-counter with its ECN service. Separate fees will apply.
To access OTC Markets and ArcEdge, add “United States (Penny Stocks)” to your trading profile.
On the OTC Markets Pink Sheets, many stocks trade well above $5. When we use the stock screener to set $5 as the maximum amount to trade only penny stocks, Morningstar ratings do not appear. Unlike the stocks with higher prices, most of the penny stocks will not have any analyst followings.
Even if the broker provides a profile, always check the stock profile directly on the OTC bulletin board. In this example, the stock is not compliant with securities regulations and is in bankruptcy.
Best US Penny Stock Broker for 2019 – Charles Schwab
- Why Buy Penny Stocks on Charles Schwab?]
- Buy penny stocks on Charles Schwab
- Invest in Penny Stocks With Charles Schwab
Fees: $4.95 per share
Min Deposit: $1,000
Charles Schwab is the full service discount broker with a white shoe polish. Investors choose Charles Schwab for its reputation and fully automated-to-human advisory brokerage service options. The Schwab One® brokerage low flat fee includes professional research from Morningstar and Credit Suisse, and advanced charting. Schwab lists more than 6,000 OTC stocks. The user-friendly broker has smoothly integrated OTC stock research and buying into its main dashboard. Or you may choose to buy one of Schwab’s small cap ETF of index funds.
- Flat trading fees
- Over 6,000 OTC stocks to trade
- Well-integrated OTC trading
Start your research of penny stocks using the Charles Schwab Market Screen. This broker provides profiles of penny stocks, but as always with penny stocks, you may have to undertake some of your own research and due diligence. If the stock is covered, you will benefit from the extensive analysis from Morningstar. The market screener allows you to quickly locate small cap stocks. Choose from Micro Cap or Small Cap and select your price criteria.
Penny stocks have had a bad rep in the past. Regulators have placed a tighter safety net under OTC markets. These stocks still have lax reporting requirements compared to stocks listed on the big boards. If they do become insolvent or break investment rules, they could be tagged as a high risk stock, downlisted to the Pink sheets, or permanently delisted. While regulators cannot protect you from loss of capital, OTC stocks covered by FINRA are less likely to be investment scams.
There is no minimum to invest in penny stocks. Online brokers will have minimums. Some allow you to start trading with as little as $5–10. A high minimum investment may force you to invest an imprudent amount in penny stocks.
Markets in penny stocks can be very illiquid. To obtain a best bid and ask quote, two bid and two ask quotations are required. One-sided quotes are not uncommon.
If you trade through a licensed and insured broker, you will have up to $500,000 in SIPC-backed insurance against losses on your investment account.
If you have invested in a NYSE or NASDAQ stock that falls below $1, the stock will be delisted from the exchange. The stock may then trade in the OTC markets.
- Penny stock markets have long been a target of illegal investing practices, including pump-and-dump schemes. To deal in securities listed in the OTCQB, OTCQX or OTC Pink boards, a broker must be registered with FINRA and the SEC. These brokers must comply with securitiess rules, including ensuring investors receive:
- Best execution
- Limit orders
- Firm quotes
- Short position disclosure
An alternative trading system (ATS) is an electronic OTC system that matches buyers and sellers of securities. They are also referred to as dark pools due to their lack of transparency as they mask the price and size of orders.
- 1 What are Penny Stocks?
- 2 Why Invest in Penny Stocks?
- 3 Where Can I Find Penny Stocks?
- 4 How to Choose a Penny Stock Broker?
- 5 How to Research a Penny Stock
- 6 How to Buy Penny Stocks
- 7 Best UK Penny Stock Broker for 2019 – Interactive Brokers:
- 8 Best US Penny Stock Broker for 2019 – Charles Schwab
- 9 What to Look for in Penny Stocks?
- 10 FAQs