With countless investment vehicles available today, traders are spoiled for choice. Yet penny stocks, defined as shares trading under $5, retain a uniquely risky reputation. But according to Zak Westphal, CEO of StocksToTrade and veteran penny stock trader, their bad rep isn't entirely deserved.
Penny stocks are well known for extreme volatility and outsized potential gains—or massive losses. Loosely regulated, with limited reporting requirements, they can seem like dangerous waters for amateur investors. However, Zak contends there are safe, sustainable ways to trade penny stocks for those with the proper strategies.
Intrigued to hear from an expert how to responsibly day trade penny stocks, we sat down with Zak for an interview:
What exactly is a penny stock?
Penny stocks refer to any stocks trading under $5 per share. They tend to be very small companies, microcaps valued at less than $300 million. The main appeal of penny stocks is that their high volatility and low prices make them more accessible to smaller retail traders looking to profit.
Of course, their lower prices also mean higher risk - penny stocks are prone to dramatic price swings on a daily basis due to factors like low liquidity and fluctuating float. You'll often see penny stocks spike 50% or crash 30%+ in minutes on good or bad news. It's a roller coaster ride!
While the volatility can be dizzying for some investors, it creates opportunities for savvy traders. The fast action levels the playing field between Wall Street and Main Street. But you have to be willing to stomach the risk and employ smart trade management.
Where can penny stocks be traded? Are they regulated?
Penny stocks typically trade over-the-counter on exchanges like the Pink Sheets or the OTC Bulletin Board (OTCBB). Now, neither of those exchanges have the same SEC regulations and reporting requirements that other stock exchanges enforce. That's especially true with the Pink Sheets - those companies don't even have to file with the SEC.
So I'd approach any pennies traded over-the-counter with extreme caution. Do your due diligence, dig into financials, read recent press releases, check company management. With less oversight comes more risk of scams or dilution. But if you trade carefully and manage positions with discipline, money can still be made even with penny stocks on the “sketchier” exchanges. The key is education and responsible trading.
What analysis should traders apply to penny stocks that may differ from big board stocks?
With penny stocks, traditional fundamental analysis like P/E ratios often does not apply. These microcap companies are too small and early-stage for typical valuation metrics to carry much meaning.
Instead, technical analysis should be the priority - study the price charts and momentum closely. Look for key support and resistance levels. Pay close attention to volume and price action trends over different time frames. Timing entries and exits is critical with penny stocks. Their prices can swing rapidly intraday on hype, news events, or technical triggers like stop losses being hit. Actively trade them rather than invest long-term.
Above all, remember that adaptability is key - don't get attached to any one strategy. Cut losses quickly when trades go against you. Take profits faster than you normally would. Penny stocks are a different ballgame.
If you were only allowed to look at 3 metrics before buying a penny stock, what would they be and why?
If I could only look at 3 metrics before buying a penny stock, it would be:
- Volume - High relative volume indicates interest and allows for liquidity to get in and out of positions. Low volume pennies can leave you stuck.
- Level 2 Support/Resistance - The real-time supply and demand is crucial for pennies. I want to see solid support where I enter and areas of resistance to take profits.
- Float - Pay attention to changes in the float size. Promoters love taking advantage of tight floats since it allows them to move the price more easily. But as the float increases, it gets harder to manipulate. So if the float has exploded recently, be cautious of pumps.
There are other useful metrics of course, but those three give me the best quick check on liquidity, psychology, promotability, and volatility. They let me gauge if there's enough interest and momentum in a penny stock for an exploitable trade. The key is that unlike blue chips, fundamentals are secondary - you have to focus on tradability.
Volatility cuts both ways with penny stocks. What risk management strategies do you use?
The extreme volatility with penny stocks can produce massive gains quickly, but it also means you can lose your shirt just as fast. That's why risk management is so critical. I always set stop losses on every trade, no exceptions, to limit potential damage if I'm wrong.
You also have to be vigilant of pump and dump schemes trying to take advantage of retail traders. I see "promoters" constantly pumping junk companies on social media then dumping shares once it spikes. Or short and distort traders trying to profit from false negative info.
I combat these risks by sticking to high relative volume penny stocks with obvious technical catalysts. I try not to trade the story or get married to any stock for too long. Take quicker profits than you normally would, especially if a stock spikes on hype and no real news. Assume there are ulterior motives driving prices rather than fundamentals.
Finally, for new penny stock traders, what’s the most critical advice you can offer?
My top advice to new penny stock traders is don't underestimate the value of quality education. The typical "learning the hard way" approach leads to blowing up your account fast with penny stocks. Seek mentors, learn strategic frameworks, study historical chart examples. Paper trade. Get immersed in successful traders' processes. Good education builds good habits.
Your goal is to develop an edge - find reliable trade setups with rules managing risk. Test them thousands of times in all market conditions. Only then take them live.
