The Do’s and Don’ts of Penny Stock Trading

Get-rich-quick schemes are the stuff dreams are made of. After all, who wouldn’t want to go to bed as poor as a church mouse and wake up the next morning living the life of a king?! And, as a matter of fact, get-rich-quick schemes will make some people rich, only it won’t be you or me, but those behind the scheme.

penny stock

CC licensed, image source: Flickr).

Penny stock trading is often painted as a get-rich-quick scheme. Heck, many advertise it as a way to get rich overnight (“let me teach you how to turn 100$ into 10,000$ in one week”). In reality, penny stock trading is a legitimate business, as legitimate as dealing in any of the major stock markets. It is the surrounding circumstances that make penny stocks such a fruitful field for various scammers and shady brokers to try to free you of your hard-earned money.

Before we go any further, let’s cover our basics. While there is no specific definition that qualifies a certain stock as a “penny stock”, we are basically talking about low value stocks (under 5$) sold outside of the major stock markets.

Back to the “surrounding circumstances” we mentioned a few sentences earlier: companies whose stocks are sold as penny stocks are usually startups and smallish ventures. In most cases it is very difficult to find any reliable info about these companies and their business activities, which makes the market ideal for various speculations and schemes. You will have companies releasing false information trying to artificially increase their value or gain exposure, brokers trying to manipulate the market by inflating the stock’s value and then selling before anyone realizes the scam, as well as many other ways people are trying to make money on other people’s naivety.

Due to a number of factors (limited information, uncertainty regarding companies and their future, etc.), the penny stock market is highly volatile, with stock values going up or down to dramatic extents. This makes it a field of high risks and high rewards, but the risks are many and the rewards are not easy to come by, especially for those lacking experience.

Plenty finance consultants will advise you to simply avoid dealing with penny stocks altogether, but the potential of high profits from relatively small investments is something many will find hard to resist. Here are a few tips on what you should keep an eye on when dealing with penny stocks.

Don’t believe the hype!

Penny stock success stories will come your way on the daily basis, touting a stock and urging you to join in on the action. As a general rule of thumb, if something sounds too good to be true, it probably is. Tim Sykes, a stock broker generally considered as the foremost authority on penny stocks, urges people to resist the temptation of buying penny stocks promising huge rewards: “You can’t invest in penny stocks as if they were lotto tickets”, says Tim. “Unfortunately, that’s what most people do, and they lose again and again”. He instead encourages investors to seek out companies experiencing a consistent earning growth over longer periods of time (for more info on penny stocks, check out Tim’s site).

Read the fine prints !

You will get most of your penny stock info from tips in newsletters and e-mails. People behind these newsletters are obliged to disclose any affiliations with the companies they tout, so make sure you carefully read through the disclosures at the end of said newsletters.

Act quickly!

If a penny stock in your possession makes a profit, don’t sit around waiting for it to gain even more value. As we already said, penny stock market is highly volatile, and you should sell for a smaller profit instead of hoping for a bigger one and coming up short.

Stay away from shorting

Selling short is the favorite gamble for a lot of brokers, but in a market that fluctuates so wildly as penny stock market does it is nearly impossible to predict which stock will drop, and how far it will drop. Unless you’re looking for a bling gamble, avoid the short sell.

Go for high volume stocks

Brokers like Sykes suggest only considering stocks worth over 50 cents and moving more than 100.000 units a day. The main reason here is safety, because you will have no problems selling high volume stocks even if you suffer a loss, while lower volume stocks might be much harder to move. Also, any stocks falling below these two criteria are deemed not liquid enough and too risky.

Cut your losses

Penny stocks are a risky business, and you should make peace with the fact that you will suffer a loss every once in a while. Before you consider a stock you should have a clear idea on what kind of gains are you looking for, and what degree of loss are you willing to accept. If your stocks go down in value to the limit of acceptable loss, don’t hesitate to cut your losses and move on to the next thing. Standing still is the worst thing you can do on the penny stock market.

Author bio:

Jenny Hahn is an independent finance and marketing consultant from Sydney, Australia who loves helping small businesses get up on their feet. You can find her on Facebook, Twitter and Google+.

2 Comments on "The Do’s and Don’ts of Penny Stock Trading"

  1. Great article. I think penny stocks should be left to traders and active equity managers; Investors buy and hold stocks for long-term.

    • You are right Lamin. Sometimes these stocks can inherent low liquidity risk and if they are not properly observed, you can be left with worthless stocks.
      Feedback appreciated.

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