Chapter Ten: Making Your Penny Stock Picks

Making Your Penny Stock Picks

Now that you know what to look for, it’s time to start making your penny stock picks

There are four things you’ll need to get started—your brokerage account, your research, your watchlist and your trading diary.

Your Brokerage Account

Brokers are basically your middlemen when you’re buying or trading stock. They run the account that you’ll log into to trade, and they’re the ones that are responsible for ensuring your shares are bought or sold after you place your orders.

You’ve probably heard about brokers like Charles Schwab or Scottrade before, but the thing you have to know is that not all brokers are created equal. A lot of people who want to get started with pennystocking will sign up with the first broker they see being advertised on TV without ever knowing that not only are all brokers different, even online brokers— the kind I use for penny stock trading —are different from other online brokers.

With that in mind, here are six things you need to know before signing up with a broker:

• Stock brokers have to be licensed. To work as a stock broker, you have to pass two exams given by the Financial Industry Regulatory Authority, Inc. (FINRA)—the Series 7 and Series 63 exams. These tests show that brokers know what they’re doing and that they know the laws governing the securities industries. If you come across a broker without these credentials, run fast in the other direction.
• Stock brokers have to make money. Every broker has a different fee structure—some charge per trade, while others set a flat rate—but all of them have a way to get paid. They might charge more if you execute your trades over the phone or need personal assistance, but even if you’re just placing trades online, expect to pay. This isn’t some free service they’re providing. Just be sure to compare prices to see which fee structure makes the most sense for how you’ll be trading.
• Stock brokers aren’t always good people. They share information with each other that isn’t easily accessible by the public. They take advantage of people—especially ignorant people who don’t know any better and have no business trading. They have bad reputations for a reason, but they’re unfortunately an unavoidable part of the process.
• Stock brokers will try to stick you with hidden fees. Wall Street is great at covering these up, but when you open your brokerage account, expect to be charged fees for everything from account maintenance to account inactivity, and from minimum balance requirement fees if you go below a certain amount to sales fees tied to certain securities, like mutual funds.
• There are many different types of brokers. Need a broker who won’t just execute you trades, but will also give you advice on everything from stock research to retirement planning and tax advice? That’s a full-service broker, but be aware that you’re going to be hit with high fees of as much as $100-200 dollars for a single trade. There are cheaper options, like mid-range brokers who charge $15-30 dollars a trade and discount brokers who charge $5-15 dollars a trade, but you’ll lose access to different perks the cheaper you go. If all you want to do is go with the cheapest option and execute the trades I describe in this guide, find a dirt-cheap discount broker and get to work.

Stock brokers typically have minimum account requirements. Like it or not, you’re not going to be able to open up a brokerage account with the $50 dollars your mom gave you on your last birthday. The lowest I’ve seen is a few hundred to $1,000 dollars, but it’s more common for account minimums to be set at $3,000 dollars, $5,000 dollars or even $10,000 dollars. But that’s just to open the account. If you want to do short stocks or trade futures contracts, some brokerages will require you to have even more in your account.

The bottom line is to read the fine print before signing on with any particular broker. Know what you’re getting into, what the requirements on you will be and what fees you’ll be charged. Even better, ask around for reviews of brokers. Don’t just make your decision based on price. Remember that you might need to get a hold of a support person in the event of an emergency. Missing out on a big play because you can’t reach your discount broker’s security team is going to cost you a lot more in the long run than shelling out for a more expensive broker with good customer service.

There’s one other thing you need to know about when it comes to brokers and that’s the pattern day trader ( PDT) rule. Basically, the SEC says that, if you have less than $25,000 in your brokerage account, you’re limited to 3 round-trip trades a week.

It’s a huge hassle, and it’s a rule that I absolutely hate because it penalizes the people who need the flexibility the most. If you’re trying to turn a small portfolio into a big one, you need to be able to act when the right setups occur. If you’re tied up because you’ve already used up your one transaction for the week (and you don’t want to get into a buy or a short that you can’t get out of), you’re out of luck. The SEC put the rule in place to “protect” small investors from big losses, but if you ask me, the whole thing is downright un-American. Since when is it okay for the government to step in and say who can and cannot make a profit off the stock market?

Let me get off my soapbox now… There are ways around the PDT rule. You can set up multiple brokerage accounts so that you can make 3 trades out of each. Or, you can work with an offshores broker that doesn’t follow the rule (or one of the handful of US brokerages that doesn’t enforce it). Or—and this is my personal favorite—you can use the strategies I’m sharing in this guide to get your account above that $25,000 dollar limit so that you’re free to play with the big dogs and trade as much as you want.

Every so often, I release a list of my favorite brokers to my students—including the brokers I work with and whose policies I like best for pennystocking (including those that can help you get around the PDT rule). If you want to be notified when I send out my next list in the future, head over to my Preferred Broker page.