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How To Find Penny Stocks: Stock Market For Beginners

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Some investors use penny stocks as part of their investment strategy. Other beginner investors use penny stocks to test the waters in the stock market. Regardless of whether you are experienced or new to investing, you need to know how to find penny stocks and what makes for a good potential investment.

What Are Penny Stocks?

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Before figuring out how to find penny stocks, it's helpful to understand what penny stocks are and how they can fit into your larger investment strategy. Penny stocks are defined by the Securities and Exchange Commission (SEC) as stocks that trade for under $5. However, this definition is simplistic. Penny stocks can cost as much as $10 a share. It all depends on their market caps.

Market Cap and Penny Stocks

Market cap, or market capitalization, is the true determiner of whether a stock qualifies as a penny stock. Essentially, the market cap shows the true value of a company beyond its current share price. It is possible to have a $50 share in one company that, in reality, is worth less than a $10 share in another company due. Whether you are looking at how to find penny stocks or the best stocks around, you should take the company's market cap into effect.

To find the market cap, you multiply the per-share-price of a company's stock by the total number of restricted shares and shares it has available to the public; also referred to as outstanding shares or capital stock. Companies' stocks are then categorized by their market cap in the following way:

  • Mega-cap companies: $200+ billion market cap
  • Large-cap companies: $10 to $200 billion market cap
  • Mid-cap companies: $2 to $10 billion market cap
  • Small-cap companies: $300 million to $2 billion market cap
  • Micro-cap companies: Under $300 million market cap

There is some variation in the definitions once the market cap drops below $300 million, and you may hear reference to micro- versus nano- stocks. For our purposes, however, most penny stocks fall under the $300 million market cap range. A few penny stocks may come from small-cap companies, though most will not.

Penny Stocks and Specialization

Some penny stocks have a low market cap because they are in a narrowly specialized industry. One example of this is the growing medical cannabis industry. There are still heavy restrictions at the federal level which limit the growth of companies in this industry and prevent publicly-traded companies from growing to a larger market cap range.

When you learn how to find penny stocks, you will want to consider if specialization is the reason for the low share price. If the market cap for a penny stock you are investigating is in-line with others in its industry, it is a solid choice. If the market cap is higher than others in its industry, that may be a good reason to invest.

Where Are Penny Stocks Traded?

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Penny stocks are not traded on most normal exchanges since they are often too small to meet the requirements to be listed. When you are ready to purchase penny stocks, you will have to do so on the Pink Sheets or on the Over-the-Counter Bulletin Board (OTCBB). These are both over-the-counter exchanges which means buyers conduct their trades over the phone or computer.

Most penny stocks are still too small to meet the initial listing requirements of the NASDAQ or NYSE. Though, a few penny stocks have been moved to over-the-counter exchanges after being "de-listed" from the major exchanges when they faced bankruptcy and severe financial difficulties. Since both the NYSE and the NASDAQ require that companies have at least a $1 per-share-price to be listed, this makes it difficult to find shares for actual pennies on these major exchanges.

Pink Sheets

This over-the-counter exchange was originally traded on pink paper and led to the name Pink Sheets. They have no minimum requirements for companies to be listed. Companies can list on Pink Sheets without having to file with the SEC or make their account statements public. Some large foreign companies use Pink Sheets to break into the American market without having to share their budget or accounting practices. The prices on Pink Sheets penny stocks are sometimes manipulated through fraud and scams. Stocks here are consideredextremely risky since it is nearly impossible to research the companies before buying in.

Over-the-Counter Bulletin Board (OTCBB)

Unlike the Pink Sheets, the OTCBB provides slightly more security for traders and requires annual audits for companies listed there. Companies on the OTCBB must also adhere to the Corporate Responsibility Act of 2002, or Sarbanes-Oxley bill. This bill put in place protections and regulations around financial reporting to prevent scams and fraud, such as happened with Enron. Companies listed on this board must file quarterly financial reports with the SEC. Many penny stocks trade on the OTCBB as a first step to reaching the NASDAQ and the NYSE.

Traditional Markets

It is possible to find penny stocks on traditional markets, like the NYSE, the NASDAQ, and AMEX. Companies listed on these markets will be subject to more stringent reporting requirements. Investors should have no trouble doing in-depth research into companies listed there.

How to Find Penny Stocks

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Penny stocks are attractive to beginner investors because of the low costs and the potential for massive rewards. However, there are larger risks involved with these micro- and nano-cap stocks. Before purchasing, you need to know how to find penny stocks that pose the least risk with the most potential for gains.

The Importance of Analysis

Every stock poses some potential for risk. However, smaller market cap companies pose greater risks because they are not subject to as much regulation and financial reporting as larger companies. Investors must be able to analyze the financial records of a company to know whether a penny stock is worth investing in.

Beyond looking at the numbers, you will want to understand the business strategy of the penny stocks you invest in. Look for business news about new acquisitions or patents with the company. Be skeptical. Make sure you are getting objective reports on the company's news. Some small companies are prone to exaggerating or misrepresenting their potential and risks to inflate prices.

There area number of risks that penny stocks pose, especially those traded on Pink Sheets where there are no financial reporting requirements. The following are a few risks from penny stocks:

  • Low costs often mean low value and potential returns
  • Inflated prices with limited shares available
  • Appear legitimate when facing bankruptcy
  • Scammers can hide among the many available stocks
  • False or misleading information without reporting requirements
  • Inflated potential profits
  • Fraud with pump-and-dump schemes

Research Tips


  • Start with some base criteria, such as price, yield, sector, market cap or Morning star rating
  • Look up the stock's disclosures and SEC filings on OTCMarkets.com
  • Compare previous spikes with previous company news
  • Review the company's financial presentations and compare to its competitors for a reality check

Stock Screening Tools

There are tools that can help you filter through stocks that meet the criteria you're looking for. There are free screening tools available, but the more expensive tools offer more features and research to draw upon. These tools include:

  • MSN's Stock Screener (Free)
  • MarketWatch Stock Screener (Free)
  • Think or Swim (Free)
  • FinViz ($40/month)
  • Stocks to Trade ($180/month)
  • Trade-Ideas.com ($118/month)

What to Look for​​​​ in Penny Stocks

  • Buy stocks you can sell quickly for large gains on small amounts
  • Aim for stocks that trade over 100,000 shares a day
  • Purchase penny stocks that have had a year of high earnings
  • Look for news that could lead to greater profits and industry placement

What to Avoid in Penny Stocks

  • Steer away from companies that recently increased the number of outstanding shares
  • Don't buy or sell more than 10% of the stock's volume
  • Don't trust "tips" from free newsletters and emails
  • Don't trust promotions or company predictions
  • Don't sell at a loss - wait out the downturn

Fundamental Analysis vs. Technical Analysis

Once you've found some penny stocks that seem to have good potential, you will want to do some further analysis. Beginners just learning how to find penny stocks may want to focus on doing a fundamental analysis.

Fundamental analysis concentrates on a company's earnings, or profits, to get a more solid idea of its potential for reward or risk. You'll want to look at the company's earnings in context. Look at the earnings per share (EPS), price to earnings ratio (P/E), projected earnings growth (PEG), and return on equity.

Beginners who do not have a finance or accounting background will want to avoid technical analysis. It is easy to become bogged down in the charts, in-depth numbers, and correlations associated with a penny stock. As you gain more experience, you may want to begin doing more technical analyzes of potential investments. Often, fundamental analysis is enough to get a solid grasp of a penny stock's potential.

CONCLUSION

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When you understand how to find penny stocks, a whole new world of investment will open for you. There is the potential to earn 20-30% returns on your investments in a few days. However, many penny traders lose on their investments. If you are looking to invest in penny stocks as a hobby or part of your larger investment strategy, do your research. Keep a healthy dose of skepticism when reading endorsements, advertisements and free newsletters. Penny stocks may not be a surefire way to strike it rich, but you can make decent profits on limited funds with a little effort and investigation.

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