Few sources in the investment world recommend penny stocks, and in the rare instances when they do, it’s accompanied by a boatload of disclaimers. But despite the highly speculative nature of penny stocks and their well-documented disadvantages, thousands of investors flock to them each year.
But what are penny stocks, the risks, and the rewards, and what are the best penny stocks on Robinhood, one of the most popular trading platforms for penny stocks?
Table of Contents
- What is a Penny Stock?
- How to Find the Best Penny Stocks on Robinhood
- 4 Things to Look for in Penny Stocks
- What Kinds of Penny Stock can You Buy on Robinhood?
- What are the Risks of Penny Stocks?
- Can You Get Rich Investing in Penny Stocks?
- What’s the Proper Place for Penny Stocks in Your Portfolio?
- The Bottom Line on Penny Stocks
What is a Penny Stock?
Once upon a time, the term “penny stock” meant precisely that – stocks that sold for pennies. It still applies, but inflation has increased the price threshold. Today, the general rule is that a penny stock can be any stock that trades below $5 per share.
The Securities and Exchange Commission (SEC) website defines penny stocks as microcap stocks. Rather than focus on the security’s price, they define it as a company with a market capitalization below $300 million.
Either way, penny stocks are typically small companies with stock prices trading at no more than a few dollars a share.
There are, of course, hard reasons why penny stocks trade at such low prices. Though they are often upstarts, they can also be mature companies that have been in business for a while but are having difficulty making real progress.
How to Find the Best Penny Stocks on Robinhood
Finding penny stocks to invest in is difficult on any investment platform, including Robinhood. Though many online sources promise riches with penny stocks, you should ignore most of them.
A better strategy is to start with a stock screener (see Take Advantage of Stock Screeners below). The benefit of screeners and that you can use them not only to locate penny stocks but also to choose the best of the bunch.
Stock screeners allow you to set specific criteria to help you narrow down potential stocks from the thousands available. Since penny stocks trade for under $5, you can set the screener to identify stocks that meet those price criteria.
You can narrow the list down further by adding additional criteria, including price changes, price-to-earnings ratio, and industry group, among other options.
Once you’ve narrowed your list to a few candidates, you’ll want to include them on a watchlist. Once there, do your best to follow news and information about the companies on the list – not an easy task with penny stocks, so you may need to track them for a while before investing your money.
IMPORTANT: Pay very close attention to is daily trading volume. As a general rule, penny stocks tend to be thinly traded. You’ll want to concentrate on those that show daily trading activity. That will make it easier for you to get into and out of the stock (liquidity), though there’s never a guarantee there’ll be a buyer on the day you want to sell.
That brings up another critical point. You may feel tempted to try day-trading penny stocks because of the low stock prices, but this is a complicated strategy. Day trading requires getting in and out of a stock on the same day. Because of the low liquidity factor, penny stocks are not suitable for this kind of short-term trading.
4 Things to Look for in Penny Stocks
Investing in penny stocks is incredibly risky. But there are a few strategies you can use to at least minimize the risk:
- Diversify your penny stock holdings. Don’t rely on a single stock to produce significant returns; understand that most will likely be losers. By investing in several promising penny stocks, you’ll increase your chance of coming out ahead.
- Buy only listed stocks. Many penny stocks trade over-the-counter, which means limited liquidity and a lack of information (see Risks of Penny Stocks below). Stocks listed on either the New York Stock Exchange or the NASDAQ offer some protection against either outcome.
- Make sure the company has something solid to offer. That should include, first and foremost, a viable product or service – crucial since many penny stocks have no legitimate product or service, which is a big part of why their shares are so cheap.
- Information on the company should come from a third-party source. Never rely on information provided directly by the company as it tends to be biased and unverifiable.
Another strategy we’ll emphasize in this guide is to make sure penny stocks occupy only a small part of your total portfolio – they’re too risky for you to bet big money.
Take Advantage of Stock Screeners
Anytime you invest in individual stocks, you should use a stock screener. That’s especially important if you invest in speculative securities, like penny stocks. Fortunately, you can choose from the best stock screeners available.
One of the best in the business is Stock Rover. It offers screening that integrates with the top brokerage platforms, and you can use them for individual stocks and exchange-traded funds. It’s a premium service offering three different pricing plans, each with its features and benefits.
For example, the Essentials plan offers more than 260 financial metrics, five years of detailed historical data, portfolio and watch list tracking investment comparisons, and more. It’s all available for less than $8 per month.
>> Read our Stock Rover review for more.
An even better-known service is Morningstar. One of the most respected investment information sources in the entire industry, Morningstar is commonly used by popular investment brokerages for information and stock ratings.
Morningstar offers two different stock screeners. The first is the Morningstar Basic plan, which is free to use. But since it has limited capacity, it’s probably not a good choice for a penny stock investor. Instead, Morningstar Premium offers best-in-class analysis and ratings of stocks, bonds, funds, and plenty of investor tools, including MorningStar Portfolio Manager. It’s available for under $30 per month. If you’re going to invest in penny stocks, don’t try going it alone. I highly recommend taking advantage of stock screeners to help you make it happen.
>> Read our Morningstar Premium review for more.
What Kinds of Penny Stock can You Buy on Robinhood?
Not all investment brokers allow investors to buy and sell penny stocks, but Robinhood is one.
You can trade penny stocks on either the New York Stock Exchange or the NASDAQ. They also make trading available in select over-the-counter stocks, giving you an even wider selection.
Another Robinhood advantage is that you can trade commission-free. Even among investment brokers who accommodate penny stock investing, many charges a commission for penny stocks. That can include a fee for stocks trading over the counter or those below a specific price level.
What are the Risks of Penny Stocks?
There are several, and each is significant.
The penny stock promise. The dream with penny stocks is that they can be purchased at a ridiculously low price, with great potential to explode in value with the run-up to even a modest price level. For example, a $1,000 investment in 1,000 shares of the stock purchased at $1 could grow to $20,000 if the stock price goes to $20. That’s a 20-to-1 return and the stuff of stock market fantasies.
The problem is very few penny stocks ever achieve these gains, and they usually stay in a trading range or zap out when the company goes out of business.
Lack of transparency. A penny stock can be listed on either the New York Stock Exchange or the NASDAQ. But since both exchanges have minimum standards, most penny stocks are not listed. Instead, they trade over-the-counter (OTC). As such, there are no disclosure standards required. Public information about these companies is often unavailable, and only occasionally when it is. That makes investing in penny stocks a game of flying in the blind.
Limited liquidity. Penny stocks are not part of the mainstream investment universe, especially if they’re unlisted. Despite the low price, shares don’t trade very frequently. You may find few buyers to sell your penny stocks to, which will most likely mean selling at a big loss. It also means a small number of sellers could cause the stock price to plummet.
Large bid/ask spreads. You may pay $3 per share for a stock with a market value of $2.25. In addition, many brokerage firms that generally charge no commissions have them on penny stocks. The combination means you’ll be starting your investment with a built-in loss.
Fraud/manipulation. Fraud is not unusual with penny stocks. Because they’re not publicly traded, they’re frequently promoted as stocks ready to take off.
They’re also frequent subjects of “pump-and-dump” schemes, where an individual or organization with a significant stake in a penny stock company attempts to stimulate interest in the stock by disseminating false information. They then use email schemes, social media, and investment chat rooms to spread the news of some big upcoming event that will cause the stock to skyrocket.
Once it does, the information source will sell its position at a higher price, causing the stock price to collapse.
Can You Get Rich Investing in Penny Stocks?
It is possible – in theory.
But theory and reality are two very different worlds.
A penny stock can experience a 10x, 20x, or even 100x price increase. The low starting price makes its movement more volatile because a penny is a greater percentage of the price.
It also helps that penny stocks are often very thinly traded (they have very low volumes). And again, theoretically, such a price increase would likely happen much more quickly with a penny stock than with an established company with much greater volumes.
But for any of that to happen, the company issuing the stock would have to experience something approaching a miraculous event.
That might be the introduction of a unique new product, a regulatory change that makes the company suddenly much more valuable, or perhaps the arrival of a new CEO from a proven company.
The likelihood of any of those outcomes is extremely low due to the precarious position of penny stock companies.
But the promise of such outsized gains draws investors to penny stocks. In reality, however, disappointment and capital loss are much more common outcomes.
What’s the Proper Place for Penny Stocks in Your Portfolio?
Never think of penny stocks as a core holding in your portfolio; they should never be the primary allocation. If you invest in penny stocks, be sure you have a well-diversified portfolio mostly of well-established companies, bonds, and cash.
Penny stocks shouldn’t occupy more than 5% of your portfolio. That will give you enough exposure to benefit from one or two issues exploding in price while limiting your losses to low single-digit percentages.
The most basic rule: don’t invest in penny stocks of money you can’t afford to lose.
The Bottom Line on Penny Stocks
It’s easy to see why investors, particularly new ones, are drawn to penny stocks. The low prices promise spectacular gains, even turning into instant riches. But the reality is very different, and that’s what you need to remember if you’re even considering penny stock investments.
That said, Robinhood is one of the better trading platforms for penny stocks. In large part, that’s because not all brokers allow trading of these securities. Robinhood does this by offering low-priced stocks listed on either the New York Stock Exchange or the NASDAQ, as well as select over-the-counter stocks. And best of all, they offer them commission-free.
Just be sure to do your homework for any stocks you’re considering investing in, and limit your total position to no more than a few percentage points of your portfolio.