Updated January 29, 2016

Study: Best Stock Broker for Penny Stocks

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The name "penny stock" can be misleading. To the untrained investment ear, it sounds like an easy trading gig with little at stake. However, nothing can be further from the truth, as it's a very volatile market that should be researched thoroughly before trading, especially by novices. It's more for seasoned traders who understand the pitfalls and the risk involved; it takes some finesse to trade in this arena — and be profitable at it.

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The Securities and Exchange Commission defines a penny stock as any common stock trading under $5/share. However, despite the fact that they're cheap, in order to achieve a big payout, you need some patience. Because of their low cost-per-share, penny stocks are traded in large quantities (i.e., it's not uncommon to purchase 50,000 shares per trade), and you could lose all or part of your investment in a very short time. Check out this Kiplinger article about the perils of penny stocks; if this type of trading still intrigues you and you're ready to dive in, you'll need to get started somewhere. Brokerages give you the access you need to these investments.

Note that penny stocks are also known by other names, including "Pink Sheets," "OTCBB" (over-the-counter-bulletin-board), and "micro caps," and all four names are interchangeable. You won't find them on the Dow, Nasdaq, or other major exchanges, which is why they're referred to as "over-the-counter." And they’re also not held up to the same level of scrutiny as stocks you’d find on the big exchanges (in other words: buyer beware).

CreditDonkey took a look at some of the online brokerages that offer penny stock trading to determine which is best overall, so that you can make an informed decision on which brokerage might suit your personal penny-stock-trading needs.

Study Methodology

To compare, CreditDonkey used three factors that play a role when choosing a brokerage to conduct penny stock trading:

  1. Cost per trade
  2. Tools and resources available
  3. Limits on trading

Online brokerages make money via commission, which they charge you every time you make a trade. Depending on your trading frequency, this can really add up, especially when it comes to additional fees and surcharges associated with trading penny stocks.

While most brokerages do allow for penny stock trading, not all of them cater to the specific needs of the pink sheet trader. Some offer tools to help trade in this specific market, while others are geared towards general research.

Not all trades are created equal, and not all brokerages will allow you to trade whatever you want, however you want. If you really want to have unlimited trading capabilities in this unpredictable market, you'll want to look for a brokerage that doesn't hinder your pink sheet investment strategy.

NO TRADE RESTRICTIONS ON PENNY STOCKS: INTERACTIVE BROKERS

  • Cost per trade: $.005 per share, additional tiered pricing based on volume 3/5
  • Tools and Resources: Detailed, sophisticated charting and real-time quotes 4/5
  • Limits on trading: None 5/5
  • CreditDonkey Score: 4/5

Yes, Interactive Brokers is known for having some of the best pricing in town, but not so much when it comes to penny stocks, as they are purchased in high-volume. Buying 50,000 shares of a pink sheet stock will cost you $250 for the entire trade with IB's price structure. And there's another caveat: This is an online brokerage specifically geared towards high-volume, seasoned, professional-level traders. It's not for casual investors looking to get their feet wet in the marketplace. That said, pink sheet trading is best suited for an experienced trader anyway, as the skills and strategies necessary to perform well in this arena require an online brokerage that caters to such an investor.

Why We Like It
There are no limits on the kind of OTCBB trades you can make. Short selling (trading on borrowed stock) is allowed, and it's very popular in the penny stock investment field. Many popular online brokerages don't allow this, so Interactive Brokers’ lack of restrictions is very attractive to pink sheet traders. The charting abilities on Interactive Brokers and the tools it offers to help you capitalize on your investment strategy are especially helpful when trading penny stocks. Its very low price per trade for high volume traders is especially attractive.

Who It Works Best For
Seasoned, active traders who know the penny stock market well and trade frequently. Investors who already use Interactive Brokers as their platform and want to try their hand at pink sheet trading.

Downsides
Interactive Brokers is definitely not for everyone and certainly not for beginners. First off, you'll need 10 grand just to open an account, and you'll pay more for each trade when you purchase a large quantity of shares (which is necessary to profit in the penny stock world). There's also a steep learning curve when utilizing the sophisticated charting and tools it offers, so you won't be able to dive right in to pink sheet trading until you've got a grasp on the resources provided and how to use them to best serve your strategy.

BEST FOR RESEARCH: E-TRADE

  • Cost per trade: $6.95 or less per trade, no surcharges 4/5
  • Tools and Resources: Extensive, one of the best on the market for novices 5/5
  • Limits on trading: Only limit orders allowed and no short selling 3/5
  • CreditDonkey Score: 4/5

Even though its prices per trade are relatively high, E-Trade makes our list because it's a great platform for both newbies and frequent investors alike. Being one of the top online brokerages in the field, there's a good chance you'll utilize E-Trade as your overall brokerage if you're a self-directed investor and, because of that, would be likely to use its platform for penny stocks as well.

Why We Like It
E-Trade has extensive tools and resources geared towards any trader. It's easy-to-follow platform is inviting for novice investors who want to get into the penny stock market. And it has excellent customer service.

The Downsides
Only limit orders (set buy and sell prices) are allowed. There is no short selling (trading on borrowed stock), and you can't trade any stock with a market value of less than $10/share until seven business days after your account application is approved. If you need assistance on a penny stock trade, you can call customer service, but keep in mind you'll be charged a $25 fee for a broker-assisted trade.

Who It Works Best For
People who use E-Trade as their overall online brokerage who like to dabble in penny stocks now and then. Also, novice investors who want a simple-to-understand trading platform, which E-Trade provides.

OPTIONSXPRESS

  • Cost per trade: $4.95 per trade, no surcharges on penny stocks 3/5
  • Tools and Resources: Large video library; live seminars and webinars 4/5
  • Limits on trading: No limit on number of shares you can buy; no short selling 4/5
  • CreditDonkey score: 3.7/5

    OptionsXpress is a platform that has a lot to offer both seasoned and novice investors alike. If you're looking to trade in pink sheets and penny options, it offers you that capability at a good price, in addition to the other perks you get from its platform.

    Why We Like It
    There are no additional surcharges beyond the regular trading commissions, so you may find greater savings here than you would with many other online brokerages. This is a great platform to trade from, with a lot of available research and tools at your fingertips. You can also buy unlimited shares, which is important when it comes to penny stocks as they're sold in high volume.

    Downsides
    It doesn't allow you to access the ask/bid price on penny stocks. Like its name states, it's geared towards traders who want to invest in options, so it doesn't support penny stock trading with the same panache as other online brokerages.

    Who It Works Best For
    Options investors who already use OptionsXpress as their online brokerage but are looking to cast a wider net and try their hand at penny stocks.

    OTHER PENNY STOCK BROKERAGES TO CONSIDER

    Ally Invest, Scottrade, and TD Ameritrade are also good brokerages to consider when playing around in the penny market game. Ally Invest only charges $4.95 per trade, but doesn't accept opening trades below 1 cent per share. Plus, there's a 1 cent surcharge per share as well. Scottrade actually has an information page devoted to penny stocks on its website, but you'll pay $6.95 per trade, plus .05% principal for any stock trading under $1. TD Ameritrade will hit you with a $6.95 fee per trade, but there are no surcharges per trade.

    Mistakes to Avoid

    Watch out. There are some hurdles to trading penny stocks that you should know:

    • Per Share Charges: Some brokers also charge a separate per share charge for buying or selling penny stocks when they are below a certain dollar value. This can eat into your gains when you sell or up the stock's price when you buy, so pay attention to your fee schedule.

    • Large Order Surcharge: Penny stocks are often bought and sold in large quantities, but doing so may cost you. Some online brokers charge an extra surcharge when your trade order is for 100,000 shares or more.

    • Minimum Trade: Some online brokers tout their low trade commissions, but they require you to execute a set number of trades each other -- otherwise you'll be hit with a fee.

    • Potential Fraud: Penny stocks are a prime target for fraud, largely because less information is typically available about them compared to other stocks. If you run into an online penny stock broker who's promising returns that seem too good to be true, that may be a warning sign that a scam is in the works.

  • Cynthia Cohen is a retail analyst at CreditDonkey, a stock broker comparison and financial education website. Write to Cynthia Cohen at cynthia@creditdonkey.com. Our data-driven analysis has been recognized by major news outlets across the country and has helped investors make savvy financial and lifestyle decisions. (read more)

    Disclaimer: Opinions expressed here are those of the author's alone. Please support CreditDonkey on our mission to help you make savvy financial decisions. Our free online service is made possible through financial relationships with some of the products and services mentioned on this site. We may receive compensation if you shop through links in our content.

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