Penny Stocks 101: Complete Guide For Beginners

Penny stock trading has risen in popularity in recent years as investors want to find undervalued companies that are poised to skyrocket in size. Young investors in particular can get a head start on their retirement savings by wisely and carefully investing or trading penny stocks in 2021.

What are penny stocks?

There is no standard definition as to what constitutes a penny stock. Some argue the definition should be taken literally -- that is a penny stock refers to shares of a company that trades under $1 per share. Others expand the definition to include shares of a company trading below $5.

Penny stocks are shares that trade at $5 or less and are typically young companies with little to no revenue.

The vast majority of penny stocks belong to companies with a low valuation, sometimes even in the millions. Penny stock companies come from all sectors, ranging from retail, pharmaceutical, leisure, technology, etc.

Why are penny stocks so cheap?

Penny stocks are cheap for the simple reason that the underlying company has little to no reputation or track record. Many penny stock companies generate little revenue and haven’t yet demonstrated to investors a viable path to growth.

Penny stocks are cheap because there is little to no investor demand to buy shares of a company with no obvious path to growth.

Some penny stocks generate zero revenue as they are still in the pre-revenue phase of their business. This is mostly the case for the pharmaceutical industry where a drugmaker of therapies to treat a disease is years away from completing clinical trials. The company’s path towards success is far from guaranteed and the slightest setback could result in bankruptcy.

In other cases, companies that have existed for a long time can find their shares dip into penny stock territory. Remember BlackBerry? At its peak in the 2000s, the smartphone maker was the clear and dominant leader in the space. One out of every two smartphone users in the U.S. used a BlackBerry.

But as the company lost focus on the market and failed to respond to the growing competition, the stock absolutely collapsed from more than $130 in the late 2000s and was finally demoted to penny stock status in 2020.

How to find penny stock winners

Many investors view penny stocks as the ideal venue to discover winning investment ideas. Sure, buying Amazon’s stock above $3,000 per share when the company is already worth more than $1.5 trillion is a solid investment idea. If it grows 10% to 15% a year, investors will pat...

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