How to invest in penny stocks in Canada
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Updated: November 07, 2024
Trading in penny stocks can be an incredibly risky venture.
Despite the risks, some investors are drawn to penny stocks for the chance to earn significant profits with a small investment.
Here’s everything you need to know about investing in penny stocks in Canada, including the risks, potential rewards, and essential dos and don’ts.
What are penny stocks?
Historically, penny stocks referred to shares trading for less than $1, but today, the term includes securities trading for $5 or less. These stocks are often associated with small or new companies and are known for their extreme volatility. The U.S. Securities and Exchange Commission (SEC) defines penny stocks as stocks trading under $5 per share, and they are typically traded over-the-counter (OTC) or on pink sheets rather than larger exchanges like the NYSE or TSX.
In Canada, penny stocks usually belong to industries such as:
- Oil & Gas
- Mining (Gold, Silver)
- Pharmaceuticals
- Biotechnology
- Cannabis
Related: Everything you need to know about investing in pot stocks
These sectors are highly speculative and sensitive to factors like commodity price movements, industry news, or regulatory changes. Penny stocks are risky and can represent companies at various stages—from start-ups with big dreams and little to no revenue to debt-laden firms nearing bankruptcy.
Why are penny stocks so risky?
Penny stocks come with significant risks due to several factors:
- Transparency / Lack of Public Information: Companies trading OTC or on pink sheets are not required to meet the same filing requirements as those listed on larger exchanges. This makes it difficult to find reliable data.
- No Minimum Standards: Many penny stocks fail to meet the minimum standards for larger exchanges, such as timely financial disclosures and annual listing fees.
- Lack of History: Companies that trade as penny stocks are often newly formed or facing severe financial distress, resulting in poor track records.
- Low Liquidity: Penny stocks often have low trading volumes, making it difficult to buy or sell without significantly affecting the stock price. This can lead to price manipulation and scam opportunities.
Penny stock scams
The classic “pump and dump” scheme is the most notorious penny stock scam. This occurs when investors or brokers buy a large number of shares, hype them up through misleading information, and then sell their shares once the price inflates, leaving other investors with substantial losses.
Tips to Avoid Penny Stock Scams:
- Be cautious of biased or paid recommendations from newsletters or social media.
- Always verify company information using reputable sources and official filings.
If you decide to trade penny stocks, you need to do so with your eyes wide open. Despite the risks, some investors are drawn to penny stocks for the chance to earn big profits with just a small investment. Who doesn’t love a good investing success story?
Let’s say you bought 2000 shares of a penny stock trading at 46 cents per share. That’s a $920 investment (maybe a ‘bet’ is more accurate) in that penny stock. If that stock happens to reach $1, then you’ll have more than doubled your initial investment.
To get that elusive 10-bagger (10x its purchase price), the stock would need to reach $4.60. If that happened, then your initial $920 investment would now be worth $9,200.
Still, the more likely scenario is the share price stays under $1 and possibly goes to zero if the company fails.
The extreme risk and volatility of penny stocks mean investors need to do their homework before investing. Rather than trying to hopelessly pick one winner, a better strategy might be to take the venture capitalist approach and divide your investment among five to 10 penny stocks – diversifying your risk and increasing the chances of finding the elusive winner.
Be extremely wary of any online newsletter promoting the best penny stocks to buy in Canada. As mentioned above, there’s no way to tell if the information is biased and/or part of a scam to promote a particular stock to benefit someone who already has a position and is waiting for you to buy so they can unload.
Finally, don’t invest more than you’re willing to lose. Investing in penny stocks is akin to gambling and should only be done outside your core TFSA and RRSP holdings and never with money, you’re counting on to fund your retirement.
Related: TFSA vs. RRSP
How to invest in penny stocks
- 1.
Open an account with a discount broker: Given their low share prices, penny stocks are more suited to frequent trading. Use a discount brokerage to keep trading commissions low and maximize potential profits.
- 2.
Research and select penny Stocks: With limited public information, thorough research is crucial. Verify listings against company details such as their official website and address. Stick to reputable sources instead of relying on unverified tips.
- 3.
Purchase shares: Once you’ve chosen a penny stock, use your brokerage platform to buy shares. Ensure you’re familiar with the historical performance and current pricing before placing an order.
- 4.
Craft an exit strategy: Liquidity issues mean you need a clear plan for when to sell, whether the stock hits your target price or drops to a pre-set limit.
- 5.
Reap profits and cut losses: Trading penny stocks requires an active strategy. Take profits when they arise and accept losses without emotional attachment to avoid compounding mistakes.
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Where to find out more about which penny stocks to invest?
I write this with great hesitation, as information on penny stocks can be extremely unreliable. In addition, news travels fast and so take any stock-specific or industry recommendation with a huge grain of salt because that information is or should already be priced into the market.
Large online brokerages, such as Questrade, offer access to OTC and pink sheet securities. However, some smaller platforms like Wealthsimple may have restrictions on penny stock access. Check with your brokerage to see if they support the specific stocks you’re interested in.
Where to find penny stocks that seem reputable:
SmallCapPower: “The industry’s leading and most trusted source for small-cap stock coverage, research, and analysis.” SmallCapPower covers a wide range of penny stocks in industries such as gold, base metals, energy, technology, sustainability, marijuana, battery metals, and blockchain. One of its columnists is Canadian author and active trader Robin Speziale.
The site is loaded with all of the latest news and insights of small-cap companies. Check out their top 10 Canadian marijuana stock picks as an idea of where to start investing in the cannabis sector.
AllPennyStocks.com: This is another good source of information to use as a starting point for investing in penny stocks. This site features more detailed analysis and charts for investors to sort through, including penny stocks to watch – a feature that uses technical analysis to identify hot penny stocks.
Remember, these sources are just starting points to give you an idea of penny stocks in which to invest. Do your own research to determine whether it’s a worthwhile investment, and make sure you understand the risks before putting your real money on the line.
Risks and rewards of investing in penny stocks
Pros
-
High potential for quick gains: Penny stocks can double or even triple in value within hours.
-
Accessibility: They are easy to buy through most brokerage accounts, making them accessible to investors looking for speculative plays.
Cons
-
Volatility: Penny stocks can experience large price swings due to their low share price. A small change in cents can result in massive percentage shifts.
-
High risk of fraud: The lack of regulation makes penny stocks susceptible to scams.
-
Lack of liquidity: Selling penny stocks at your desired price may be challenging.
-
Potential for total loss: If a company’s stock price falls to zero, investors lose their entire investment.
Dos and Don'ts of penny stock investing
Do
-
- Use a reputable discount broker.
- Invest only what you can afford to lose.
- Capture gains when they happen.
- Accept losses and move on without regret.
Don't
-
- Don’t overextend your investments.
- Avoid placing penny stocks in registered accounts like TFSAs or RRSPs.
- Never borrow money to invest in penny stocks.
Final thoughts
We’ve all heard of successful penny stock stories, and wouldn’t it be nice if we had our own tale of earning triple-digit returns on a penny stock investment?
The fact is, penny stocks are some of the riskiest investments out there, and investors need to be cautious. Know that you’re trading on what little public information is available, and what is available may be unreliable.
Be prepared to lose money, maybe even all of it, if the company goes bankrupt or turns out to be a scam. Penny stocks should only make up a tiny fraction of your portfolio and never be counted on for your retirement savings plan.
Investing in penny stocks is like taking a big swing for the fences in baseball. You may hit a home run, but more than likely, you’ll strike out. With that mindset and eyes wide open, you can try your luck at penny stocks and hopefully find that diamond in the rough.
FAQ
Robb Engen is a leading expert in the personal finance realm of Canada and is also the co-founder of Boomer & Echo, an award-winning personal finance blog.
Bridget Casey is the award-winning entrepreneur behind Money After Graduation, a Canadian financial literacy website aimed at 20 and 30-somethings. She holds a BSc. from the University of Alberta, and an MBA in Finance from the University of Calgary. She has been featured as a millennial financial expert by Yahoo! Finance, TIME Magazine, Business Insider, CBC and BNN. Bridget was recognized as one of Alberta's Top Young Innovators in 2016.
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