How to Invest in Penny Stocks


Authored by Lee Wright in Stock Trading
Published on 12-02-2009

Investing in the stock market can be a risky endeavor. If you are not sure about risking much money or you just want to get some investing experience, you may want to consider investing some penny stocks. Typically priced below $5 per share penny stocks can offer a great way for small investors to trade with risk, but with the possibility of great returns.

Penny stocks, also known as nanostocks and microcap stocks, are typically stocks issued by companies trying to raise expansion money when they cannot get financial backing from mainstream sources. To put it another way, the company may have issued penny stock shares to generate funds because they could not get investment bankers interested in an IPO. Some penny stocks are considered very volatile and risky for this reason.

Since penny stocks are so volatile, you should only risk money you can afford to lose. Obviously no one wants to invest and plan to lose their money, but penny stocks are especially not the place for retirement money or for gambling the money you need to meet basic expenses. Penny stocks can yield great rewards, but they can also fall fast and hard, so investors should not be banking on a large return or even breaking even.

You should research a penny stock’s trading volume before investing. Do not just pay attention to the average volume but make sure there is a substantial amount of trading going on every day. You cannot buy and sell as needed if the stock trading volume is too low. No one will want to buy what you are offering or conversely be offering to sell when you want to buy. Also check the number of trades per day to make sure the trading volume it not just a few insiders trading large blocks of stock. Again in this situation, you will not b able to buy and sell as needed if most of the stock trading volume is from a few insiders.

You should also research a company’s profit and loss statements. Although many penny stock companies will operate at a loss it is important to analyze the extent of the loss and the reason behind it. Determine if there are indications that expansion will eventually lead to a profit and try to figure out if the company will need to procure further financing. If the company sells more shares to raise capital that will dilute the value of any shares you own.

Once you have chosen a penny stock issue do some calculations on return on investment. The relatively small value of penny stocks means that even a small price fluctuation can equal a large percentage of investment. A $0.02 movement up or down on a $0.10 stock can equal a 20% gain or loss. Twenty percent is a decent return on investment and at the very least you should put in a stop loss order to lock in that 20% gain. If it goes up another ten percent you may want to sell and if it goes down it will automatically sell and hopefully you will salvage some profit.

Penny stocks can be great way to try and maximize profits. With careful research and diligent tracking you can realize some sizable gains from investing in penny stocks, but they are not for everyone. The volatility and risk associated with penny stock investing makes them a poor choice for investors approaching retirement or for more than 10% to 20% of the value of any stock portfolio. Investing in penny stocks can yield either positive or negative results and no investor should risk too much of his or her capital on such a volatile aspect of the stock market.

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