Penny Stocks Investing – What You Should Know

Penny stock investing

Penny stocks investing, as the title suggests, is investing in shares that you can buy at ridiculously low rates. These stocks are available literally for pennies. They can be purchased for as low as a dollar per share or less. These stocks are usually of very small companies, which have a market capitalization of less than $500 million.

They are not traded at the major stock exchanges like NASDAQ or NYSE but are listed in the pink sheets or the OTCBB (Over The Counter Bulletin Board). This is because these companies are unable to meet listing requirements. They are also referred to as pink sheet stocks, nano stocks, small caps, micro caps, or juniors.

There are no regulatory or listing requirements that provide security to shareholders, which makes investing in penny stocks risky. There are no accounting standards, and the shareholder gets no information about the change of ownership of shares, etc. This makes it a potential source of fraud.

However, with proper research, investment in penny stocks can be a profitable venture. Also, not all companies listed with pink sheet stocks should be considered fraudulent. Some are good companies, which are too small to meet the requirements of the New York Stock Exchange (NYSE) or NASDAQ. Many such companies have a bright future.

Unlike blue-chip stocks, penny stocks have greater volatility, which implies they possess the potential to reap rich dividends in a relatively short period of time. Often times, investing in these small companies at rock bottom prices can end up making investors very wealthy.

However, finding these companies requires thorough research. One of the important steps you must take is to ascertain the number of shares that the company has on a “float”. Float is the technical term for the number of shares of the company being traded.

Since penny stock companies are unregulated, they are not bound to report these details to the public. The information, however, can be found in TV interviews, given by the representatives of the company occasionally, and are sometimes archived on their websites.

Other sources of such information include forums on websites where stock brokers chat with each other. Also, you read articles and reviews written about the company, which will give you a good idea of the float. For instance, if a company has a very high float, this means that it is merely issuing extra ones to keep afloat. Therefore, that company would not be worth investing in.

Further, you have to scrutinize the product of the company. For example, find out if the company would face challenges in selling its products for different reasons, or whether patent issues would allow some other company to introduce a similar product in the market. All of which would affect the value of the stocks. Another significant consideration would be whether the product would appeal to the target consumers.

Investing in penny stocks is about defining the rules and playing the game by the rules just as the big investors do. Big penny stock investors started out small or even smaller but played by the rules. They grow by the defined set of rules.

If you avoid learning these rules, you lose money. Losing money instead of learning these rules is something that is unacceptable and potentially cripple a new investor — even though something in your brain is telling you that “it doesn’t matter, they’re only Penny Stocks after all!”

However, if you follow these few simple rules religiously, you should be ahead of the penny stock investing game.

The number one and the MOST important rule is — Never, ever, under any circumstance borrow money to invest. If you want to stay out of trouble as an investor, this is possibly the biggest rule.

Yes, I know! You think you have the upper hand with some inside information that could help you build a huge portfolio in no time!

There are many others before you with the same mindset but sorry to disappoint you — they were all WRONG!

Please, don’t jump on a story with the only answer being borrowing money. If you start to lose money investing, then the debt repayment will come directly out of your pocket. If this happens, trust me — you are in big trouble.

When you eventually start to make money from the investment, then you have to repay the loan instead of saving or reinvesting the funds. This money will stand by and haunt you as you continue to try to make a living off the stocks you are investing in.

Always save up to be able to invest as a rule of thumb, debt will be chased until you finally catch up by being farther behind than you were, to begin with.

DON’T DO IT!

The number two rule to keep in mind is investing in profitable companies when investing in penny stocks. I know that reads and sounds awfully silly and a waste of breath but believe me sometimes people simply invest in a company without determining if the company is profitable or not.

Either they like the name itself or the product/service the company offers or they know someone working with the company. Don’t be the investor that buys a stock and then tunes in to the television or logs on to the internet to see that its quarterly earnings are down and its revenue per share is dropping like a four-ton boulder of the Empire State building — very hard and very fast!).

Research how to find a profitable company and then determine which company to invest in. Guides for how to evaluate companies, their accounts declarations, and markets should be readily available.

Also, do all of your homework, research, and analysis before you buy a stock that is not garnering any type of attention.

One important area of focus for investors is volume, anything less than one million shares per day is not worth touching. It is a pointless task to purchase a stock that is trading 9,000 shares a day because it will be nearly impossible to sell once you are ready to do so.

Stocks need attention to have liquidity, which basically implies that for it to sell it must have value. Don’t be stuck with a rising stock that you will be unable to sell later. Don’t just think of the profit you’ll generate, think also about the mechanics of actually being able to realize that profit.

Oh — and in case you forget! DON’T BORROW MONEY TO INVEST!!

If you want to be a successful penny stock investor, you’ll need to be an intelligent one. There are very few requirements to start trading in penny stocks. It can be broken down into three main things.

Related Post: What is the Most Important Rule in Investing

Money

The money we are talking about is not just the money that is sitting in your bank account. It is not the money that you use to pay for your rent, your car, or your food. Penny stocks can be extremely unpredictable and although you might make a great deal of money it is also true that may lose everything, so it is important especially when you are starting out with penny stocks that you only use money that you can afford to lose. After you have built up a nice profit, you can re-invest your profits from past trades which will snowball your earnings.

Old money with a lope on it
Old money with a lope on it

Gain Knowledge on Penny Stock Investing

This is without a doubt the single most important factor in determining whether your budding career as a penny stocks investor will be a spectacular triumph or a dismal failure. If you are just starting out as an investor, there are various guides or books you can buy and it is a good idea to read several of them before spending investing.

Although reading books on penny stock investing is good, however, they will not help you with specific decisions such as whether to buy a particular penny stock or when to buy or sell. They will provide you with a great background on how it all works and are invaluable in building a fantastic knowledge base.

Have A Plan for Penny Stock Investing

Make a plan before you invest any money, and stick to it at all times. This will not only help you become disciplined but also organized in terms of your time and investments. Keeping things simple will result in less stress.

Your plan should consist of what investments you are going to make, why, and how much you will invest. It should also include your exit strategy (the price at which you will sell your investment to make a profit) and also the time you want to allocate for your investments each day (the time it takes to monitor and research them).

money money money
money money money

Conclusion

Now that you have got all the major elements in place, you are set for the whole world of investing in penny stocks. However, remember that knowledge is the most powerful tool you have to make your penny stocks successful, so start learning today.

Titus Ojo

Titus is an Economist and he has taken courses in personal finance. He is an economic analyst by day and a blogger by night.

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