Best Brokers for Penny Stocks Trading
Based on 29 different variables, here is a summary of the top five brokers for trading penny stocks.
- TD Ameritrade - 4.5 Stars
- Fidelity - 4.5 Stars
- Charles Schwab - 4.5 Stars
- Interactive Brokers - 4 Stars
- E*TRADE - 4 Stars
Penny stocks, companies whose shares trade for under $1, are risky investments. The vast majority of time, companies trade for pennies per share because of poor financial metrics, which results in an uncertain future and more risk. In fact, according the US Securities and Exchange Commission (SEC), "The term 'penny stock' generally refers to a security issued by a very small company that trades at less than $5 per share."
Penny stocks typically trade Over the Counter (OTC), meaning they are not listed on a formal exchange like the NASDAQ. Instead, they are instead listed as a Pink Sheet or trade on the OTC Bulletin Boards (OTCBB). If a company listed on the NASDAQ trades below $1 for a certain period of time (or fails to meet other quality metrics), the company can be delisted and forced to convert to a OTCBB or Pink Sheet listed security.
That said, not all companies that trade OTC are penny stocks. Some are legitimate companies growing their business with the goal of one day being listed on a major exchange such as the NASDAQ or NYSE. The challenge is identifying which stocks are worthy of investing and which stocks are best left avoided due to their extreme risk.
How to Choose a Broker for Trading Penny Stocks
For penny stock trading, first and foremost, select a broker that offers flat-fee trade commissions with no gimmicks. Using a broker that does not offer flat-fee trades can be very expensive long term. Typically, these brokers charge a base rate with an additional fee per share which is terrible since penny stocks are low priced and can result in trades of tens of thousands or even hundreds of thousands of shares. Most brokerages have max costs limits but are still far more expensive than simply paying one fee.
Example 1: Broker A charges a flat-rate $6.95 per trade. You buy $5,000 worth of stock XYZ at a price of $.13 per share, totaling 38,461 shares (5,000 / .13). Your cost to buy the shares is then $6.95.
Example 2: Broker B charges $.005 per share with a max cost of 0.5% of the trade value. You buy $5,000 worth of stock XYZ at a price of $.13 per share, totaling 38,461 shares (5,000 / .13). Your cost to buy the shares is then $25 ($192.31 using per-share method or $25 cap, thus capped at 0.5% of trade value).
|TD Ameritrade||Fidelity||Charles Schwab||Interactive Brokers||E*TRADE|
|Stock Trade Fee (flat)||$6.95||$4.95||$4.95||N/A||$6.95|
|OTCBB / Pink Sheets||Yes||Yes||Yes||Yes||Yes|
|Research - Pink Sheets / OTCBB||Yes||Yes||Yes||Yes||Yes|
Penny Stocks Fraud
Since most penny stocks trade for pennies a share for good reason, institutions avoid these companies. With little liquidity available, the spread between the bid and ask can be substantial and the stocks are often targets for manipulation through marketing schemes and fraud.
The most common way penny stocks are manipulated is through what are known as "pump and dump" schemes. The company will pay penny stock promoters to blast hundreds of thousands of emails and post on social message boards fake news and falsified information about the company to generate excitement and encourage unknowing investors to buy. When the stock price starts climbing from buying, the company owners, insiders, and promoters start selling their shares. Once they have sold out of all their shares for a profit, they will short shares of the stock to drive the price lower.
Penny Stock Myths
With penny stocks, it is a common misconception for investors to think they are getting "more for their money" by buying shares of stock for pennies per share instead of dollars per share. This is completely false. Stocks that trade for pennies are actually much more risky, as highlighted above, and stocks that trade for $10, $50, $100, or higher per share are companies with financials strong enough to support institutional ownership alongside, more importantly, a listing on a major stock exchange such as the NYSE.
While the risks associated with trading penny stock trading are high, investors can make money, which is why they are still traded each and every day. Retail investors will forever be attracted to cheaper share prices alongside the dream of buying a stock for pennies a share and watching it surge to dollars per share, yielding dramatic returns. Sadly, this is very rarely the outcome for penny stocks. Instead, the majority end of up eventually going bankrupt and shareholders lose everything.
5 Tips for Success Buying Penny Stocks
In summary, here are five important tips to remember when buying penny stocks.
- They are risky - Penny stocks trade for less than $1 per share for a reason.
- Be aware of fraud - Watch out for pump and dump schemes.
- Be aware of paid promotions - Ignore emails claiming amazing returns, they are fake.
- Do your own research - Research the company before you buy.
- Be aware of costs - Select a broker with flat-fee trades.