Trading penny stocks can help you gain quick returns by investing minimal capital.
However, penny stocks trading isn’t without risks, and you’ll need to know the basics before investing.
After all, even with the many ways technology is changing the investing landscape, you’ll need to be strategic, leverage the right tools, and know what to look out for to ensure you’re making smart investments.
Keep these six tips in mind before diving into the world of penny stock trading to help you spot legitimate investment opportunities, limit losses, and avoid common pitfalls.
Penny stocks: A brief overview
Before starting to trade penny stocks, it’s crucial to learn what they are to know how to trade and invest in them effectively.
According to Investopedia, penny stocks generally refer to small company stocks that trade for less than five dollars per share.
While some penny stocks trade on large exchanges such as the New York Stock Exchange (NYSE), most trade over the counter via the OTC Bulletin Board or OTCBB.
Tips and tricks to penny stock trading
While trading penny stocks can get you sizable gains, it also comes with risks that cause significant investment loss within a short period.
Increase your chances of making sound investments and reducing massive loss by learning from a reliable guide on trading penny stocks and these tried and tested tips.
1. Perform thorough research
It’s crucial to choose stocks yourself or get the advice of experts and experienced traders before investing.
Conduct thorough research to avoid falling for misleading information and claims that turn out to be scams or fraudulent entities posing as “companies” selling penny stocks.
One of the well-known scams involving penny stocks was run by Zirk de Maison, who created almost a half-dozen small public shell companies, which were entities that didn’t have any actual assets or do business.
He then offered public shares in the company’s penny stocks and used it as a pump and dump scheme.
Take the time to research and cross-reference the information from several resources before investing in penny stocks. This helps ensure you’re trading and investing in legitimate companies.
2. Understand the numbers
Avoid immediately investing in the company you find suitable. Monitor the company for a while to get a good idea about the stock price’s movement.
Set a good entry price, something fair enough to get in, and an exit price once you’re in.
Determine the best times to sell your shares should they move lower to limit your loss, including when you should sell higher to gain profit.
3. Stay away from free stock picks
Penny stocks are generally thinly traded and lightly followed. These factors, combined with penny stocks’ low price per share, make them ideal vehicles for scammers and fraudulent promoters.
For instance, some scammers will buy tons of almost bankrupt, near lifeless penny stocks, then exaggerate and lie to increase the share price. They might claim that the company is about to close a huge deal with big companies such as Google or land a serious FDA clearance.
This usually increases the penny stock’s value and, in turn, creates profits for scammers. As the shares’ value increases, fraudsters will then sell their holdings.
The shares typically collapse back to their near-worthless state after the scammers take their profits and move on.
4. Avoid keeping a short position
Penny stocks are highly volatile, which means being on the wrong end of a short can lead to potentially significant losses.
Remember that your losses are limited to your investment when you buy a stock, so don’t sell short since the large shifts in penny stocks can make your short position extremely risky.
5. Assess the underlying company
Don’t just focus on technical signals when choosing penny stocks, but study the underlying company as well.
Find solid earning trends and patterns, including companies that make new highs paired with strong fundamentals.
Doing so helps you filter out good companies (listed as penny stocks) that are great for making long-term investments.
6. Track the volume
Opt for stocks with a high number of shares trading hands daily.
For instance, a too low volume can make it challenging to find a buyer to liquidate your position. This isn’t a good position to be in when stocks are on the decline.
Also, the size of your position will impact how easy it is for you to get out. You’re better off keeping your position fairly small to the average volume trading daily.
Make smart penny stock trading decisions
It’s crucial as a beginner in penny stock trading to know the basics before you start investing.
Doing so can help you avoid the usual pitfalls, limit potential losses, and detect legitimate investment opportunities.
Do your research and use the tips in this guide to help you learn what to avoid and look out for, allowing you to make smarter, more strategic penny stock trading decisions.