Investing

So, let's dive into penny stocks: what they are, how they work, and what you need to know before buying, especially if you're new to penny stock investing in Canada.

Penny stocks explained: What are they?

Penny stocks are low-priced shares, often tied to small or early-stage companies. Unlike large-cap stocks on the TSX or NYSE, they're usually traded on over-the-counter platforms (OTC markets).

Because of their low price, penny stocks can seem like an easy intro to investing, but their low market cap and limited public information also makes them riskier.

Why do people buy penny stocks?

The appeal is simple: high reward for a small investment. Imagine buying shares for pennies, only to watch them skyrocket in value. It's happened before—Canadian companies like Aurora Cannabis and Ballard Power Systems started out as penny stocks before gaining traction.

Plus, low prices make these shares accessible. You don't need thousands of dollars to start. For many new investors, that's a big draw, but not one without risk.

The risks of penny stocks

Let's talk about penny stock risks, because there are a few that you should be aware of before you consider dipping your toes into this speculative corner of the market.

1. Low transparency

Many penny stocks don't file reports with securities regulators, or if they do, the data is limited. This makes it difficult to assess the financial health or future prospects of the company.

2. Low liquidity

These stocks often trade in low volumes. If you want to sell, there may not be buyers, especially in fast-moving markets.

3. Pump-and-dump schemes

Since penny stocks are volatile and lightly regulated, they're often the target of fraudulent schemes. Promoters may hype up a stock, watch it rise, and then sell—leaving unsuspecting investors holding the bag.

4. Volatility and delisting

Some penny stocks are cheap for a reason. Companies may be on the verge of insolvency or have been delisted from major exchanges for failing to meet listing requirements. Bottom line—penny stock risks are real and you could lose your entire investment if you're not sure what you're doing.

Where penny stocks are traded

Unlike many larger stocks found on the TSX or NYSE, most U.S. penny stocks trade on over-the-counter (OTC) markets, which typically have less regulation and require fewer company disclosures. In Canada, many very small companies that might be considered 'penny stocks' trade on recognized exchanges like the TSX Venture Exchange (TSXV) and the Canadian Securities Exchange (CSE). Regardless of where they're listed, these types of markets generally require investors to conduct significantly more diligence due to varying levels of disclosure.

How to buy penny stocks

Still curious and wondering how to buy penny stocks? Here's what you need to know:

1. Choose a broker with OTC access

Not all Canadian brokers allow trading on OTC markets, but you can access these markets using Questrade's trading platform.

2. Research the company thoroughly

Before you buy, dig deep into the financials (if available), company news, leadership team bios, and industry outlooks. If that information is hard to find, that's a red flag.

3. Understand the costs

Penny stocks may come with higher trading fees, especially if you're buying through OTC markets.

4. Set a hard limit on investments

Only invest what you're willing (and able) to lose. A good rule of thumb for penny stock investing in Canada is to treat it more like a speculative bet than a core investment.

5. Use limit orders

Due to low liquidity, market orders can backfire. Use limit orders to avoid buying at inflated prices or selling for less than what you'd like.

When penny stocks go right

While inherently risky, penny stocks occasionally do pay off. Investors who got in early and held on saw triple-digit returns—and sometimes more. But for every winner, there are dozens that don't quite work out the same way. The key is to recognize potential and act with discipline.

Should you invest in penny stocks?

That depends on your risk tolerance, financial goals, and how much time you're willing to put into research. Penny stocks are high risk, high reward, but not for everyone. If you're an experienced investor looking to add some spice to your portfolio, a small allocation to penny stocks may make sense. But, if you're just getting started and don't yet have a solid investing foundation, it's best to wait.

The last word on penny stock investing in Canada

Penny stocks may not be for everyone, but for the informed investor, they can open doors to unique and rewarding opportunities. With the right research, a clear plan, and a dash of caution, these low-priced shares can offer an exciting way to diversify your portfolio and gain exposure to up-and-coming sectors.

Whether you're just learning about how to buy penny stocks or are ready to add a few speculative players to your mix, remember: every great company started somewhere! With a careful approach, penny stock investing can be a smart part of your broader investment strategy.