Penny stocks are really cheap and entice you with their promise of huge profits. These are stocks that sell for under $5 per share. They are super cheap to invest in and if you happen to choose the right one, you could be getting in on the ground floor of something huge. There are plenty of sites out there promising that they know the trick to finding the penny stocks worth investing in. Then there are the investors who think the secret to success is scouring the penny stock listings for the hidden gems. While there is some truth to this, it’s definitely not always going to be successful. Here are some things to consider before you invest in penny stocks:
#1 Penny Stocks Are Cheap but High Risk
Penny stocks often appeal to those who aren’t ready to invest a lot of money or who are looking for a steal. But it’s important to fully understand the risk you are taking on before you make any investment. And penny stocks generally carry the same risks:
- Lack of information – making smart investment decisions requires data and information. But it’s not as easy to find the needed information on penny stocks. The information that you do find needs to be carefully scrutinized because there are a lot of unreliable sources.
- No minimum standards – in order to trade on a major exchange like the NASDAQ or NYSE, a company must meet certain minimum standards. This includes filing with the SEC on time and providing certain information. The OTCBB (where penny stocks are traded) does not have these requirements.
- No history – the majority of penny stocks are new companies. Being so new, they don’t have much of a record for you to look at. This means you don’t really know how they will weather a storm or handle a crisis because the company simply has never had to before.
- Liquidity – penny stocks have especially low liquidity. This means that you may not be able to sell the stock at all or you’ll be forced to lower the price below the value.
These are important and serious risks that you need to be aware of. Any source you find promising that their penny stock is a sure bet should not be trusted. With that said, just because a company is a penny stock does not mean it’s a bad choice. Apple and Coca-Cola were once new, inexperienced companies.
#2 It Takes Dedication & Endurance
With such high risks comes the possibility of high reward but getting that reward is not easy. One of the mistakes people make is assuming that investment just means putting your money in the right place and waiting. This is not even true for stocks on the major exchanges.
Penny stocks require active, daily management. You need to be diligent and thorough at every stage of the process. You will also likely need to be trading on a daily basis and you need to be prepared to lose. Every investor goes through losses as well as wins.
The trick is winning more than you lose. But if you are not prepared to lose the money you invest, you are not ready to make the right choices and take the right risks in order to win.
#3 It’s Not an Overnight Success
The promise of riches is enticing but just as you need dedication and endurance, you also need time. Stocks don’t grow overnight. This is especially true of penny stocks. New companies might not see any real growth for a few years. And more importantly, trading penny stocks is not always about waiting for a company to explode into success.
In many cases, it’s about buying a stock at, say, $1.20 per share and selling them a few days or weeks later at $1.30 per share. Penny stocks fluctuate pretty rapidly. So most of your money will be made through strategically selling the stocks at just a few cents above the buying price. This way, you will gradually but fairly consistently grow your wealth.
#4 Develop a Strategy that Manages Risk
All penny stocks are high risk and you will never be able to bring that risk down to zero. However, there are ways that you can work to counter that risk and keep it a more manageable level. Here are a few options you might consider adding to your strategy:
- Find Penny Stocks on Major Exchanges. You can find some penny stocks trading on the NASDAQ and NYSE. These stocks do comply with the minimum standards set by those exchanges which means they are more likely to be legitimate and have up to date SEC filings.
- Stick to high volume stocks. High volume means that there are a lot of shares out there. This means that there are a lot of people buying this stock. It has nothing to do with the price of the stock but it shows that there is enough interest in buying. So you will be able to sell your shares when you want to sell them.
- Set rules and targets. Treat this like a day job. Aim to earn a certain amount of money each day through a series of small trades. Set up rules for what kind of stocks you buy and at what point you sell them. Follow those rules day in and day out.
With consistency and a solid risk management strategy in place, you can actually make money on penny stocks. However, most people do not have the risk tolerance or know-how to make a living on these high risks stocks. You should do a lot of research and find an investment simulator online. A simulator helps you practice your ideas and strategies before you invest your real money.