If you interview a group of people across all corners of the world, there’s a high chance that a majority of them will list being wealthy as one of their lives’ primary goals. Most of us want to own that elusive dream home, that sexy supercar, those expensive high end clothes, those designer sunglasses, that romantic vacation down the Italian Riviera etc. However, unless you happen to win the jackpot in a casino or your ticket number wins the lottery, the best way to become wealthy is through investing. Money makes money, those words ring really true in this scenario. And don’t worry, you don’t need to start off with a million dollars in your trust fund to start making money, you can start small and earn big eventually. Penny stocks are cheap to buy and although they can help you earn money, don’t expect to be driving away in a bright yellow Lamborghini by just investing in a few penny stocks. A famous example of someone earning lots of money with the help of penny stocks is the man whose life’s story inspired the superhit Martin Scorsese flick The Wolf of Wall Street, Jordan Belfort. Even though penny stocks helped Belfort get rich really quick, he didn’t use them the way you might expect. He didn’t just trade with his penny stocks based on some stock tips, he did it by convincing small time investors to invest their money into penny stocks. If you convince a large number of small investors to invest a small sum of money each, you will end up with a large sum of money in total. Belfort convinced these small investors that if they invested even a small amount of money in penny stocks, they could get rich very quickly. When so many small investors purchased penny stocks at once, they went through an artificial inflation in their prices. After the prices rose, Jordan Belfort would go on to sell his company’s position in those stocks, pocketing a huge amount of profit and consequently cratering the price of those stocks. This left the original investors with worthless stocks and in essence, Belfort conned those people out of their money with the mirage of penny stocks. In 2003, when Jordan Belfort was eventually caught, tried, convicted and sentenced for his crimes, he was ordered to pay $110 million in damages to the victims of his scam. Almost 17 years later, he still hasn’t delivered on that. Jordan Belfort’s entire operation was a classic example of a “pump and dump” scheme. Such schemes and penny stocks often go hand in hand in the financial world. Penny stocks sound like something very safe and non expensive. It sounds like something which won’t be a big problem for investors. However, they can prove to be extremely hazardous for investors from time to time. In case you are wondering “what penny stocks are/how can you buy penny stocks in Canada”, this post has got you covered. Let’s find out more about penny stocks.

How To Buy Penny Stocks in Canada: Penny Stocks 101

What’s A Penny Stock?

Before we discuss the details about buying penny stocks and investing through them, let’s clear out on our definition of the term. First and foremost, you should not define penny stocks in a literal manner. Very few penny stocks will cost as less as a penny or $0.01. As per the Securities and Exchange Commission’s report on penny stocks, they are referred as “microcap” stocks, and defined as companies with market capitalization of less than $300 million. Penny stocks are more or less unregulated and as a result of that, there isn’t a precise cutoff or threshold price which defines a penny stock. However, based on practical experience, most people would concur that penny stocks generally trade for less than $ 5 per share. A penny stock is never going to be listed for trade on a major stock exchange like the New York Stock Exchange or NASDAQ. This doesn’t mean that cheap stocks are necessarily penny stocks. Rite Aid Corporation, for instance, trades for a heck of a lot less than $5.00 a share, but since it is listed on the New York Stock Exchange, it would never be referred to as a “penny stock.” Now that we have some clarity in regards to the definition of penny stocks, let’s move on to learning about trading them.

How To Trade Penny Stocks?

If you haven’t skipped this post’s introduction and at least skimmed through it, you would’ve inferred by now that investing in penny stocks is quite risky and not really recommended for every investor. However, in case you still want to trade in penny stocks, we will tell you how. 

Paper Trade

Try trading penny stock first using only imaginary money—paper trading, it’s called. Pick your stocks, track them for a predetermined number of weeks, and see how you fare. If you win big for the specific reasons you predicted you would win big, you might be ready to commit some real money. With all those imaginary winnings, buy an Italian  supercar and treat yourself to a week-long imaginary holiday in Italy.

Do Your Homework

There’s so much lousy, corrupt information out there about penny stocks, it may prove difficult to find a consistently reliable source on the matter. Needless to say, don’t trust any one source on anything, and assume that even if you find two sources recommending the same stock, they may be working together to fleece you off your money. Sure, it may sound like we’ve become paranoid, but scams can be pretty well coordinated. Despite the fact that he happens to have made his name in penny stock trading, financial personality Timothy Sykes offers some pretty sage advice in this article, including, “ignore penny stocks success stories,” and “read the disclaimers.”

Buy Through A Broker

Don’t ever buy penny stocks directly from someone who, for instance, calls you on the telephone to pitch you an investment opportunity. If you fall for this, we have another cool investing opportunity you might consider. Since penny stocks tend to be so inexpensive, you’ll want to find a platform that not only trades OTC stocks, but also offers very low commission, if not commission-free trades in order to make sure that nearly all of your money winds up in the invested, not spent on fees. Human brokers tend to charge multiples of what an online brokerage would charge, so avoid them if at all possible.

How Are Penny Stocks Traded?

All penny stocks are sold over-the-counter, or OTC, but unlike with your local Rite Aid and grape cough syrup, there’s no actual “counter” over with to purchase anything. An over-the-counter or OTC stock is a stock that’s not traded via a stock exchange. You’ll often hear these stocks referred to as “unlisted,” which may sound fancy and exclusive, like the phone number of a celebrity, but it’s in fact just the opposite. OTC stocks don’t trade at any centralized location, but instead through dealers via phone and computer.

What Are the Risks of Buying Penny Stocks in Canada?

The fact that penny stocks aren’t listed on a centralized exchange is what makes them particularly dangerous for most investors. People may complain about the cheating ways of big corporations, but the truth is, in order to be listed on any public exchange like NASDAQ, a company must by law disclose a good many facts about their finances. So while Apple must file public earnings reports on a quarterly basis, OTC companies aren’t required to do anything of the sort. In other words, if someone tells you an OTC company’s new pizza slicing yoyo is flying off the shelves in North Korea, and their stock will soon quadruple, you’ll just have to take their word for it.

In its big 2016 paper, the SEC was pretty decisive on how much of a suckers’ bet penny stocks tend to be: “A synthesis of recent academic literature reveals…that OTC stocks tend to be highly illiquid; are frequent targets of alleged market manipulation; generate negative and volatile investment returns on average; and rarely grow into a large company or transition to listing on a stock exchange.” Let’s get into the risks in detail

Liquidity

Liquidity and manipulation are both keys to their inherent danger for investors. When you want to buy penny stocks in Canada, you need to know a lot about the stock markets.  Markets operate according to the law of supply and demand, and the more a stock is traded on any particular day, its so-called “share volume” increases. Higher liquidity tends to create a pretty streamlined source of buyers and sellers who basically agree on the price a stock should buy and sell for. Should a stock be illiquid, that is, have a share volume of considerably lower than a million shares per day, this will contribute a growing “bid ask spread,” the difference between the price buyers are willing to pay, and sellers are willing to sell. If you’re trading Apple, which trades millions of times a day, the bid-ask speak might be a penny. On the contrary, if you buy a penny stock like Flybynight Discount Airlines which only trades about six times in a day, you might struggle to get rid of your position in the stock unless you are willing to settle for much less. The main reason behind that is the significantly large bid ask spread. Getting rid of a penny stock could become like unloading a house in a week. Whenever you try to sell a house in a rush, you are bound to lose a big percentage of your investment. When a stock is pumped, then dumped, sellers will have virtually no market to sell their shares. Speak to the victims of Jordan Belfort for more details.

Manipulation

Manipulation is the creative engine of the old “pump and dump” scam, some unseen force that seeks to move a penny stock in one direction or another in order for the schemer to profit from the movement. A few years ago, a federal judge sentenced a guy named Gregg Mulholland to twelve years in prison for boosting the stock of a “social network” business called Cynk Technology that had neither revenue nor assets, by 24,000% and pocketing $250 million in gains after dumping the company stock at its height. Using aliases like “Charlie Wolf” and “Stamps,” Mulholland represented himself to potential investors as an uninterested party with a hot stock tip. This is the danger of a lot of the intel you might find on penny stocks. Because there’s so little public information on these companies, the stock prices are frequently manipulated by interested parties masquerading as neutral observers. They will seek marks by sharing their tips in places like newsletters and mass emails.

If someone you don’t know ever tells you he comes bearing the key to make you rich quick, you should treat them as you might a stranger who emails you with a tale of a Nigerian prince’s fortune that only little-old-you have the power to liberate. Investing in penny stocks based on some “anonymous tip” is as dangerous as helping the despondent Nigerian prince.

What Are The Alternatives To Buying Penny Stocks Online?

Without any doubt, the biggest USP of penny stocks is their extremely low cost. To buy a single Berkshire Hathaway stock, you need to shell out roughly $300,000. If you are just starting out on your investment journey, a stock that expensive will definitely be out of your reach. In such scenarios, penny stocks will be far more appealing. But these are hardly the only opportunities for investors looking to invest with a small amount of money. Here’s where you should invest your money instead of penny stocks:

ETFs

If you’re at all familiar with the philosophy of the father of Modern Portfolio Theory, Harry Markowitz, you’ll know that he believes the key to successfully investing is diversification, that is, not putting all your eggs in one (investment) basket. So rather than investing in one or a handful of penny stocks, you might instead consider buying a little sliver of the biggest 500 companies in the American economy through buying a (fairly affordable) share in an S&P 500 tracking ETF like those offered by any of a number of big investment advisors. (Of course, ETFs and all other stock investments are speculative, and you need to understand that you may lose some or even all of your investment). You can try your hand at Gold ETFs as well.

Robo Advisors

Certain automated investing services, in exchange for a reasonable annual fee, will provide you a fully diversified portfolio of stocks and bond ETFs if you can come up with as little as one dollar to start. An account can even be opened with zero dollars, though the returns on an investment that size tend to be pretty disappointing. So try and invest a slightly more significant amount. Money makes money, remember that.

Micro-Investing

Can’t afford to invest a couple hundred dollars in an ETF? How about the $.37 to round up your $2.43 coffee purchase to $3.00? A few ingenious apps have popped up that now allow you to invest the spare dimes, nickels, and quarters by rounding up to the nearest dollar any purchase you make with your credit or ATM cards. The big ones will allow you to begin investing with as little as $5.00.

So that was your crash course when it comes to buying penny stocks in Canada. While some of the most shrewd and clever salespeople in the world have earned millions through penny stocks, they haven’t done it in the legally or ethically correct manner. While penny stocks in Canada do sound appealing with their incredibly low prices, the risks and pitfalls are far too many. However, in case you still want to buy penny stocks in Canada, make sure you follow all of our advice and exercise the necessary precautions. Remember, if something sounds too good to be true, it most probably is not.