Want to make mind-boggling returns on a black-box investment? How about throwing $500 at a Reddit penny stock. Most of the time, that amount would have gone nowhere. But, had you bought HUMBL (OTCMKTS:TSNPD) in October, the blockchain startup would have turned that $500 into $3.4 million today. Many other picks saw equally notable gains this year.

For decades, the sleepy world of penny stocks drew yawns from Wall Street investors. Few “real” investors risked shopping in the graveyard of de-listed, zombie companies. But 2021 has changed all that. With the rise of retail trading, regular investors have become kingmakers of the over-the-counter (OTC) and penny stock world.

Much of the investment will still go to waste. The average penny stock loses 60% per year, according to long-running academic studies. But investing in even one of these winners will cover these losses a thousand times over. Some may even become world-beating companies; rising stock prices allow cheaper capital raises, planting the very seeds that pave the way to success.

Reddit penny stocks aren’t for everyone. But for those looking to invest, here’s how to stay ahead of the curve.

The Rise of Reddit Penny Stocks Investing

Many investors can’t even agree on a proper definition of a penny stock. Some look at a stock’s primary exchange: Companies listed on OTC markets are generally illiquid and low-priced, making them an ideal definition of “penny stocks.” Other investors look at a stock’s price: Anything below $5 will cut it for most. (Those with bigger pocketbooks might accept any figure below $10).

Regardless, investors broadly agree that penny stocks are low-priced, risky companies that can return thousands of percentage points.

And that has made them extraordinarily tempting targets for risk-taking Reddit investors seeking quintuple-digit gains. The first week of February, for instance, saw more OTC trading than during the first six months of 2020 combined. Today, stocks below $5 together are now worth $2.3 trillion, according to GuruFocus, a stock tracking website. Add stocks under $10, and the figure increases to $6.5 trillion. Put another way, cheap stocks are now worth as much as the Big 4 tech firms combined.

That shift has made some lucky investors phenomenally rich. A basket of the top-10 OTC stocks has returned 24,100% in the past six months, far more than the modest 37% gains for the best S&P 500 performers.

Want in? You’ll need a particular set of skills that’s unlike anything Wall Street investors have ever considered.

Riding the Reddit Penny Stock Train

In a world where a firm’s entire market cap gets dictated by its last trade price, a small number of dedicated retail traders can send a stock flying in a random direction. And as r/WallStreetBets investors proved to GameStop’s short-sellers, this so-called “dumb money” can wreak havoc on a hedge fund’s best-laid plans.

With penny stocks, Reddit has taken this a step further. Since 2020, subscribers to the popular thread r/PennyStocks have grown ten times over to 1.4 million people. And where r/WallStreetBets (WSB) might have influenced the direction of several dozen stocks, the penny stock crowd has made kings out of far more. According to Unbiased Stock, a Reddit stock tracker, r/PennyStocks typically covers three times the number of stocks that WSB does, despite having far fewer subscribers.

The size of these companies also matters. The typical pick on r/PennyStocks comes in at just $310 million, compared to $10.5 billion for WSB, making Redditors with high karma (a measure of Reddit influence) the literal kingmakers of the penny stock world.

By following these highly influential accounts, investors can front-run the markets much like how high-frequency traders once used President Donald Trump’s tweets to earn alpha.

Take 88 Energy (OTCMKTS:EEENF), for instance. The long unprofitable Alaskan oil company saw shares rise from $0.0001 in January to 2 cents after getting picked up by the subreddit.

Any lucky soul who bought the 467,500 traded shares on Jan. 7 might have turned $50 into $10,000 (assuming they could achieve the $0.0001 price). But was 88 Energy’s sudden rise well-warranted? Heavens knows. The only important thing was that influential Redditors were actively promoting the stock.

Are Penny Stocks Legitimate?

Many skeptics might see this as a return to the “bad old days” of boiler room pump-and-dump schemes. Back then, stock promoters would call up unsuspecting investors to hard-sell worthless companies. Even now, the SEC finds itself mired in stamping out hucksters using social media to promote stocks they secretly own. (In the case of celebrities like Elon Musk promoting cryptocurrencies, the water gets even murkier).

But Reddit’s r/PennyStocks crowd is something different. Most are regular Joes, looking for a like-minded community to share ideas. Many of the posts also border on parody — a product of the free-wheeling, fun-loving nature of the social media site. And while a few members turn out to be financial professionals – RoaringKitty, GameStop’s biggest Reddit promoter, was a FINRA-licensed professional — most are in it as amateurs.

As Reddit’s market clout grows, SEC and other regulators will struggle to differentiate between pump-and-dumps versus legitimate commentary. Many of r/PennyStocks calls rise for legitimate economic reasons. Others are more borderline cases – was 88 Energy’s rise a case of mistaken identity, rampant stock promotion or an improvement in economic outlook? No one may ever know.

But even as lawmakers continue to scratch their heads, one thing is clear: These market movers will only grow larger as more investors jump aboard.

How to Invest in Reddit Penny Stocks

Most people will rightly turn their noses on penny stocks. Instead, they’ll attempt to follow time-tested advice: Fund an IRA and buy a combination of index funds and highly profitable long-term stocks. S&P 500 ETFs, CSX (NASDAQ:CSX) and American Water Works (NYSE:AWK) come to mind.

But what about those who want the potential for more significant gains? If you’re looking to put in $50, $500 or even $5,000 into the OTC casino, Reddit has created a way for ordinary investors to profit.

In the past, most penny stocks once followed a similar pattern: An inactive company would live in hibernation for years before inexplicably rising on insider trading. The moment the reason got announced — usually via official press release — insiders would have already sucked out the upside, leaving other investors holding the bag.

Reddit changes all that.

Instead, thousands of cyber sleuths now patrol the web for the slightest hints of price action. And instead of calling up investors one by one, these retail investors can use platforms like Reddit, Twitter and Discord to instantly share their thoughts with the entire world.

Consider a high-profile case from late last month. When short-seller Hindenburg first targeted SOS Ltd (NYSE:SOS) on Feb. 28, shares of the Chinese cryptocurrency miner initially tumbled 25%. The allegations of outright fraud were so damaging that even your author wasn’t sure whether SOS had a working mining facility. Among other issues, the firm’s press release photos showed the wrong crypto miners. The company’s official headquarters, meanwhile, led investigators to a hotel room in central China.

Reddit users immediately sprang into action. The following day, cell phone videos of an SOS-branded mining operation began surfacing on Reddit and other popular stock discussion sites. As fear and uncertainty began to lift, SOS stock rebounded 70%, finishing even higher than before the Hindenburg piece. The video would eventually end up on the main SOS page, burnishing the new Reddit detectives’ power.

Should You Invest in Reddit Penny Stocks?

Plenty of bad agents will use these methods for personal gain – at least one Reddit stock promoter has already gotten hit by a shareholder lawsuit. Even the SOS saga hasn’t reasonably concluded yet.

But for investors with an ear for Reddit chatter, following these trends and getting out early opens the door to supernormal returns. It’s going to take a watchful eye. But investors looking for superior risk-return investments shouldn’t ignore the Reddit penny stocks bonanza of 2021.

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.