How Do Penny Stocks Work

How Do Penny Stocks Work

You’ve probably heard at least one story about an investor making a large profit investing in a penny stock that doubled or tripled in value. They can seem like the perfect bet, assuming you can strike gold buying the right one of them.

What Are Penny Stocks?

The term “penny stock” usually refers to stocks that are priced under $1, although the SEC considers any stock under $5 to be in this category. Investing in penny stocks is risky because there are reasons why they are priced so low. They may be companies that are nearing bankruptcy or have unproven products. Thus, it’s a gamble to guess which one will recover and become more valuable in the future. They’re also low volume, illiquid assets, meaning that it can be hard to sell them to someone else if they don’t turn out to be a good investment.

How Do You Invest in Penny Stocks?

Penny stocks trade like other stocks, though they usually are not listed on major exchanges. The difference with these assets from well-known stocks is their low volume and susceptibility to price manipulation. This makes them riskier to trade because you can wake up to unpleasant surprises. They are also regulated more closely by the SEC to catch investor fraud.

The positive side of penny stocks is that they require a much lower initial investment compared to mainstream stocks. It’s possible to choose a basket of them and make a profit if a couple recover in price. If you’re willing to risk the capital to invest in them, they can pay off.

Things to Know Before Investing in Penny Stocks

Here’s a run down of the risks you’ll need to keep in mind when considering penny stock investments:

– High Risk: These stocks may never recover from the problems that have caused their price to drop below $1. They may go bankrupt and stop trading.

– Low Market Captitalization: These stocks are sometimes called micro-cap because they are low priced and don’t have a large number of shares in circulation.

– Less Information Available: It can be difficult to research these stocks and judge their fundamentals properly. Sometimes you only have market gossip to work with.

– Low Volume: These stocks have been abandoned by most investors, so there’s little interest in trading them. This can cause high price volatility, and it can be difficult to exit a position.

– Price Manipulation: Low volume and high volatility trading makes these stocks targets for price manipulators. Sometimes a stock will be “pumped” with media buzz to make its price rise for a short-term gain.

– Regulators Watch Them: The SEC will sometimes intervene when a penny stock exhibits tell-tale signs of price manipulation. If trading is halted, you may get stuck in a position.

– Lack of History: Some penny stocks are new companies that have yet to prove a product or revenue stream. The market is waiting to see if they’ll establish themselves or fail early on.

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How to Invest in Penny Stocks for Beginners

How to Invest in Penny Stocks for Beginners

If you’re new to investing, you’ve probably heard a lot of terms thrown around – some of which you may be fairly comfortable with, and others which may have you looking for more information.

The terms “penny stock,” “pink-sheet,” or OTC stock, come up a lot, and the information you find might be conflicting. This article will break down the basics of penny stocks for beginner investors.

Penny stocks are any stock which trades for under a dollar a share. Most commonly these stocks trade on the over-the-counter market also called pink-sheets. Some of the companies trading on major exchanges, like the NASDAQ, trade for under a dollar, but they are rare.

The first thing you need to know is that penny stocks are extremely volatile. They carry more risk than any other type of stock. Because penny stocks are not typically traded on the major exchanges, they are not subject to the same regulation as larger stocks and are therefore much more easily manipulated.

Penny stocks are typically offered by new companies with no or little record to back them up. Alternatively, some penny stocks are offered by companies who are failing and have been delisted by the major exchanges.

Because many of the large companies who currently trade on the major exchanges started out as pink-sheets, or OTC stocks, some will argue that buying penny stocks is a great way to get in on these big companies BEFORE they make it big and the stock prices climb. This is a sound point, the problem is that there is no way to know which of the many companies trading on the over-the-counter market will make it big and which will fail.

Other proponents of penny stocks use them strictly to make a quick profit by day-trading. This type of investor buys into a penny stock, and as soon as the price goes up a bit, they sell it – the idea being to make a quick profit on the movement in price. Because of the volatile nature of penny stocks, their prices can fluctuate wildly from day to day or even minute to minute. Of course, the flip side of this is that the prices also drop very suddenly and investors often lose rather than profit.

If you are seriously considering trying your hand at penny stocks, there are numerous platforms, including some offered by brokers, which allow you to “paper trade” for practice before risking your hard-earned cash.

These platforms allow you to make trades, just as you would if you were actually buying and selling stock, but without spending any money. In this way, you can see what your trades would have done and get a feel for the types of losses/gains you can make trading penny stocks.

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What are Green Stocks?

What are Green Stocks?

Green stocks are shares of ownership in companies that do business in environmentally friendly ways. These companies tend to be involved in activities such as developing alternative energies, reducing carbon footprints, controlling pollution, and recycling. While firms that are prominent in their industries and have proven to be perennially profitable are called “blue chips,” green stocks, which are also known as “green chips,” come with significantly higher risks.

Despite these risks, green stocks are attractive to investors who are environmentally conscious and want to support the growth of businesses they see as being more responsive to earth-friendly priorities. However, although investors tend to be willing to take on the risks of green stocks during bull markets, they are also apt to abandon them during bear markets. This trend was observed in 2003-2007, when high oil prices spurred keen interest in alternative energy and made these green stocks elite performers.

The good times came to a screeching halt as the Great Recession hit in 2008-2009. When traditional energy prices plummeted to dirt cheap levels, demand for alternative energy likewise sank and took green stock prices with it. This inherent volatility for green stocks is exacerbated by the sector’s relative dependence on the availability of government subsidies.

Investors who are willing to weather the risk and volatility that come with green stocks may eventually be handsomely rewarded. Since the end of the Great Recession, green stocks have rebounded nicely along with the broader market. To the extent that historical momentum appears to be on the side of environmentally friendly businesses, it is reasonable to expect the future to be bright for their market performance.

While risk and volatility have to be weighed carefully in investing decisions, investors interested in green stocks now have more options than ever. As they have performed well in the market, green stocks have been increasingly included in mutual and exchange-traded funds, and many funds hold green stocks exclusively. This surge of interest has been fueled by both investors who believe in the morality of green investing and those who consider more conventional businesses to be economically and environmentally unsustainable.

Those interested in green stocks will have to decide which specific strategy is right for them. For example, one strategy, known as Fossil Fuel Free (FFF), aims to completely exclude from portfolios any companies that are involved in any part of conventional energy sources, including oil, gas, coal and even nuclear power. However, some investment professionals with solid green credentials argue that investing in the efficient use of fossil fuels is the more realistic way to gradually reduce our dependence on them.

Accordingly, as green investors evaluate their investments, they have to make a call on how much deviation from an ideal standard of greenness they are willing to tolerate. An example of the tension that can occur took place when Brookfield Renewable Energy Partners was removed from the Green Alpha Global Enhanced Equity Income Portfolio. Although the vast majority of Brookfield’s operations are in the area of renewable energy, it did acquire two natural gas plants, which caused it to fall short of the FFF standard.

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What is Market Cap?

What is Market Cap?

Market cap, short for market capitalization, is the total market value of all of a company’s outstanding shares. Market cap is calculated by multiplying the current share price by the number of outstanding shares.

Many investors mistake the market cap for a company’s worth or value, but really it is a better indicator of a company’s size and current price based on share price which – as every investor knows – can fluctuate wildly.

Knowing the size of a company is beneficial for numerous reasons, especially in determining risk. Larger companies tend to be more stable and less volatile than their smaller counterparts.

Depending on your investment strategy, you may need to use market cap to help determine if a particular investment is a good fit for you. Large-cap stocks, which have high market caps, are more stable and tend to provide long-term returns, but will not likely give you quick, large profits. Medium and small-cap stocks carry more risk but provide opportunity to make quicker turnarounds.

For the average investor market cap is sufficient to determine whether the stock is a good purchase option. But if you want to know what a company is actually worth, you need to dig deeper.

To determine a company’s true worth or value, the enterprise value (EV) is a better tool.

The enterprise value is the market cap plus debt, minority interest, and preferred shares, and minus total cash and cash equivalents.

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What is a Limit Order?

What is a Limit Order?

A limit order is an order to buy or sell a stock at a specific price. A buy limit order initiates a purchase at a set price or below. A sell limit order sells stock for a set amount or higher.

Unlike a market order, in which investors purchase stock at the current market price, buy limit orders allow you to set a price at which you want to buy a stock. If the stock reaches that price, a market order is initiated and shares are purchased at the price set by the limit order.

The same applies to a sell limit order. After you set a sell limit order, the shares will only be sold when market price reaches that number and a buyer agrees to buy for the sell limit price.

Limit orders allow investors to take advantage of market volatility and help you avoid paying more than you want for a stock or selling for less than you’d like.

Of course, there are limitations. If you set the limit price too high on a sell limit or too low on a buy limit, the order can be canceled and investigated.

Some brokerages also charge higher commissions on limit orders which can cut into your profits, so be sure to check with your brokerage before attempting to set limit orders.

Another factor to consider is that when setting a limit order, execution is not guaranteed. Because your stock will only be bought or sold if that set price is reached, it is possible – and likely – that the set price will not be reached and you will miss the opportunity to buy or sell when most advantageous.

Limit orders can be set up as day limit orders or good till canceled (GTC) limit orders.

Day limit orders are only good for the day in which they are set. For example, if I were to set a day limit order at the opening of the stock market today, it would automatically cancel at the end of today’s stock market hours.

A GTC limit order, on the other hand, is in effect until canceled. In other words, if I set a GTC limit order today, it will remain in effect until I cancel it or until the set price is reached and the stock is traded.

Some brokerages do set limits on GTC orders – 60-90 days for most brokerages. Of course, you can always initiate another GTC order if it is canceled by your broker.

Setting limit orders can eliminate some risk and stress for investors, but also carries its own set of risks. Investors should be sure they understand all risks before investing in the stock market.

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What are Dividends?

What are Dividends?

Dividends are shares of profits paid out by companies to their shareholders on a regular basis. They can take the form of either cash or stocks. Typically only solid, blue-chip companies pay dividends. Since these companies’ stock prices stay relatively stable, offering dividends is one way for them to attract and retain investors.

Cash dividends are paid per share and are stated either as a dollar amount or a percentage of the company’s market value.

Stock dividends function the same way, except rather than pay shareholders in cash, companies issue additional shares to each eligible shareholder.

How much individual shareholders receive in either cash or stock dividends depends on how many shares they hold.

Dividends are typically paid out on a quarterly or yearly basis, but occasionally companies will offer a one-time dividend in the case of excess capital due to mergers, litigation, etc.

The amount shareholders receive in dividend payments changes based on the company’s performance, and companies who pay dividends may stop doing so at any time.

Dividends can be a great way for long-term investors to increase their holdings. If you were to reinvest your dividends, for example, you would compound your investment. You would own more shares without coming out of pocket, and the more shares you own, the more your next dividend payment would be, and so on, and so on.

Many investors retire and live completely off dividend payments, never touching their principal investment.
DRIPs (Dividend Reinvestment Plans) offer a convenient way for investors to automatically reinvest any monies received as dividends. Not all brokerages offer this service, however, and investors are taxed on all dividend payments, even if that money is reinvested. In other words, if you reinvest your dividends, you will be paying tax on money you never actually receive. But, due to the nature of compounding, those who reinvest their dividends tend to earn much more than they pay in taxes.

You should consider including dividend stocks in your investment strategy as they are an important part of a well-balanced portfolio and provide opportunity for compounding growth.

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