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How to Invest in Penny Stock

How to Invest in Penny Stock

Investing in penny stocks is one of the riskier behaviors that traders and investors may engage in within the greater stock market. Experts define penny stocks as stocks with a share price under a certain amount, usually under $1 per share. Although some beginners like to invest in these cheap stocks, their low dollar share prices often come with more volatility and risk. If you want to get involved in this kind of trading, here are some of the most common steps recommended by experts who advise on how to invest in penny stocks in a reasonable, prudent way.

Doing Your Homework

Know that several factors make penny stocks particularly risky. If you’re thinking about investing in penny stocks, it’s a good idea to understand the risks before you wager hundreds or even thousands of dollars on a stock or a portfolio of stocks. The following factors make investing in penny stocks particularly risky:

Lack of information/history. Penny stocks aren’t necessarily traded on the stock exchange. Because they aren’t traded on the stock exchange, penny stocks don’t have to file with the SEC, meaning they aren’t publicly scrutinized. If trading a stock is a bet on how well the company is going to perform, and bets are buoyed by information, penny stocks are bets without a lot of information.

Open a brokerage account. In order to invest in any stocks, you will need to have a straightforward way to make transactions. New online brokerage accounts offer easy access to stocks with low commissions and minimal annual fees.

Make sure that your online brokerage account gives you the information that you need about stocks to help you make the best decisions. The best brokerage accounts include charts, historic prices and more to help the individual trader to pursue the best portfolio.

Look at trade status for penny stocks. Experts point out that penny stocks often have a low share price related to specific situations. Look out for certain warning signs to spot the most risky kinds of penny stocks on the market.

Check to make sure that available penny stocks are traded over a regular market exchange and not as over-the-counter. Over-the-counter, or OTC, stock listings don’t require the same disclosure and regulation as larger stocks, and that can create additional risk.
Look for delisting or signs of decay in more established penny stocks. Another risky type of penny stock is a major company where the share prices gradually wither away to a very low dollar value. Some of these purchases can still be good decisions, but when a company is perilously close to bankruptcy, it may not be a good idea to invest this way. If a company has already been delisted, there’s usually no point in buying more shares, and the company’s stock ticker will usually have a different ticker symbol to show that it has been delisted.

Don’t always believe the hype. Penny stocks have been a bastion for fraudsters for some time now. You want to make a little bit of money, but don’t let the allure of quick money make you an easy target for fraudsters.

If you receive an email recommending a particular penny stock, check the disclaimers below to see if the boosters writing the recommendation are being paid for their services. If they are, this is a clear giveaway to steer clear of that stock. Remember, good (i.e. undervalued) stocks are kept secret by the pros, not advertised en masse in an email.
One way that fraudsters make easy money is by investing heavily in a stock, hyping it up using less-than-honest business practices, and then finding gullible buyers who are willing to take it off their hands. This strategy is called pump-and-dump.[1]

Choosing a Strategy

Complete a technical analysis of penny stocks. Technical analysis is a broad term for all sorts of research on the stock in question. Do as much research as possible to make sure that you are putting your money into the best penny stocks with the most potential for growth.

Ask yourself: Is this particular stock riding a 36-week high because of awesome business practices, or because it has recently been picked up by several newsletters and a team of traveling salesmen?
Don’t trust what company management has to say. Don’t be content with letting company management do your research for you. That’s a recipe for disaster. Many penny stocks are scams created by insiders to reap profits, not reputable engines with growth and solid business practices.[2]

Don’t short penny stocks. Shorting is a bet that the price of a particular stock is going to fall instead of rise in the future.[3] Going “long” is betting that the price of a stock will rise instead of fall in the future; it’s what most people bet when buying a stock. Shorting penny stocks may seem enticing because of puffed up prices and fraud, but it’s actually not a great idea. Finding penny stocks to short is hard, and it’s easy to lose half of your investment in a single squeeze.

Choose a trading strategy. Without an overall strategy for trades, your investment in penny stocks will not often be optimized for success. Think about how you will use buys and sells to gradually accumulate capital.

Consider a sell quickly strategy. Don’t get too greedy and look for a 1,000% return on investment (ROI). If you can make 20% or 30% profit on your initial investment, consider selling before the stock takes a tumble.
Consider a buy and hold strategy. Buy and hold takes a cheap stock and keep it in your portfolio until such a time as it experiences a significant increase in price. While holding onto most stocks is a winning bet, holding onto penny stocks may be a losing proposition.

Opt for high-volume stocks, especially in the beginning. Stocks that trade at least 100,000 shares a day are the only penny stocks liquid enough to be safe to trade. If you find yourself the not-so-proud owner of a low-volume stock, you may find it very difficult to unload your stock when you want to, or when fate forces your hand.

Stick with stocks that are also at least 50 cents a share. Stocks that are lower than 50 cents a share and that trade less than 100,000 shares a day are no-nos.

Look for stocks that experience an earnings breakout. Stocks that are riding 52-week highs due to product launches or a surge in market share are fair game if they trade more than 250,000 shares a day. The trick here is interpreting why the stock has experienced a breakout. If you determine that the breakout is due to pump-and-dump, stocks with earnings breakouts are obviously not as safe as those with actual evidence to back them up.

Don’t trade more than 10% of the stock’s daily volume. It’s more difficult to unload a big volume of stock, even though the allure of buying big and making a simple killing is there.

Execute a buy. When you have done all of the above, it’s time to test the waters with a purchase bid through your brokerage service. Make sure to look carefully at how your brokerage account accomplishes this transaction and how it keeps records to make sure the information that you need is available at tax time.

Never fall in love with a stock. Never get so attached to a stock that you fail to think rationally about its possible benefits or detriments to you. Stocks are about recording profits; if you’re not accomplishing that goal, it’s okay to step away from the trading table.

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