If you ask anyone in the finance world about investing or trading penny stocks, the most common response you’ll get is: “Don’t do it. You’re likely to lose your money because 90% of penny stock companies are scams. These companies are only interested in selling shares, not growing their business.” And the truth is, trading penny stocks is inherently risky. So, here’s the most important advice when it comes to penny stocks: Only invest money you can afford to lose.
But if penny stocks are so risky, why do people still trade them?
The answer is simple: the potential for high returns in a short period of time—if you know what you’re doing.
If you’re still reading and have decided you want to explore penny stocks, it’s essential that you have the right tools and guidance to help you navigate the risks and maybe even come out on top.
Step 1: Finding the Right Penny Stock to Buy
The key to investing in penny stocks is doing your homework. Research, or due diligence (DD), is critical. There are plenty of websites that can assist with your due diligence—one great resource is www.stocks-reporter.com.
When investigating a company, here are the key areas to focus on:
- Share Structure: Look at the Authorized Shares (AS) and Outstanding Shares (OS). A company with a high number of OS relative to AS might signal risk of dilution.
- Transfer Agent Transparency: Ensure the company’s transfer agent is transparent and credible.
- SEC Filings: Check for accurate and consistent filings with the SEC (Securities and Exchange Commission).
- Financial Track Record: Review the company’s financial history to understand its profitability and performance.
- Competitive Position: Consider where the company stands within its industry.
- Business Model: Is their model sound and scalable?
- Earnings Power: Can the company generate consistent revenue and profit?
- Valuation: What is the company’s potential value? Is it undervalued or overhyped?
For example, when examining share structure, you want to ensure the company is not issuing excessive shares, which could lead to dilution. A good sign is when the OS is close to the AS. Monitoring Level 2 data can also help you gauge any dilution activity. Additionally, following company insiders can offer valuable insights.
Step 2: Deciding When to Buy
Once you’ve identified the penny stock you want to invest in, the next step is determining your entry point. You need to figure out the optimal time to buy and execute the trade correctly.
Patience is key—watch the stock’s movements over several days and analyze the charts for trends. It’s highly recommended to learn basic chart reading skills, or at the very least, seek advice from experienced traders. There are numerous online communities where you can ask for help with chart analysis.
A key tip when buying penny stocks is: Always try to buy at the BID price—this is typically the best price available.
Step 3: Knowing When to Sell (Exit Strategy)
Having a solid exit strategy is crucial. The timing of when to sell can be as important as when to buy, and it varies from trader to trader. However, a good strategy involves planning your exit immediately after purchasing the stock.
One recommended approach is:
- Sell 50% of your position after a 20%-30% price increase (PPS spike).
- If the stock rises another 10%-20%, sell another 50% of your position.
- Let the remaining portion ride for a bit longer—monitoring news, momentum, and trading volume.
Your exit strategy should be flexible, adapting to market conditions and news flow. However, a general rule of thumb is: always sell at the ASK price to avoid disrupting the momentum of the price run.
TIP: Never forget to take profits—it’s easy to get caught up in the excitement of a rising stock, but always lock in your gains to avoid giving them back.
Trading penny stocks can offer significant rewards, but it’s also fraught with risk. By following the steps outlined above—researching the right stocks, patiently timing your entries, and setting a flexible but disciplined exit strategy—you can increase your chances of success while minimizing potential losses. Just remember: only invest what you can afford to lose, and always be prepared to walk away if things go south.