Here are 7 tips for anyone who is still willing to invest in penny stocks, despite the risks.
Understand that it is a risky investment
Investing is always risky, but investing in penny stocks is especially high risk. If you have some money left over that you can afford to take high risks with, then go ahead and gamble. Want to invest your entire retirement nest egg in penny stocks? We strongly suggest you don’t.
Short term or long term?
What is your plan with your investment? Are you the day-trader type who has time to carefully monitor the ticker and (at least try to) sell off your penny stock at the right moment? Or do you want to make a somewhat longer investment in penny stocks? If you don’t have time to constantly monitor your assets, go for companies with solid earnings growth rather than the flavor-of-the-day toted in the latest newsletter. Also, always ask yourself: is this stock making a 52-week high because of company earnings or because it was featured in a three popular investment blogs?
In general, penny stocks are not recommended for long term investments. If you have made a 20% or 30% earning in a few days, it is probably time to sell. It is of course easy to become both excited and greedy and think “I made a 20% profit in three days, imagine how large a profit I will make if a wait another two weeks to sell!” That type of greediness has been the pitfall for many penny stock investors and is one of the reasons why so many fail to get off in time even when all the signs of a pump-and-dump are there.
Be wary of penny stock success stories
There are two good reasons to not let yourself be mesmerized by penny stock success stories. One is that you only get to hear about the one successful investor who managed to sell off his penny stock in time, not about the other 99 guys who lost money. The other is that these success stories tend to be promoted by people who really want you to invest in specific penny stocks, buy their penny stock investment tool, etc. Instead of just promoting a certain penny stock, they fill their blogs and social media accounts with appealing success stories to warm you up to the concept of penny stock trade.
Don’t trust company management
On a well-regulated stock exchange, information made public by the company itself will be one of the most important sources of information for investors and analyzers. When you are dealing with OTC penny stocks however, you need to be much more suspicious of company management than on a well-regulated stock exchange. (This is not to say that all stock exchange companies are run by saints and all OTC companies by crooks. You should always be careful and use you best judgment.)
Penny stock companies are quite often companies that are either newly formed or has been sucked into a downward spiral heading towards bankruptcy. In both these situations, management are often quite desperate to get the stock up.
High volume penny stocks are less risky
A good rule of thumb is to not trade in penny stocks that are trading less than 100,000 shares a day. With lower trading volume than that, it can be very difficult for you to find a buyer when you want to sell your penny stock and you may have to decrease the price significantly to attract any interested buyers.
Kill your darlings
It is easy to get emotionally attached to a small company that you think have a great product that will revolutionize the world, especially if the management team are also likeable people with a great background story. However, sticking with this company through tick and thin this might not be the best idea from a financial point of view. Sometimes, the best financial decision is to sell – even if you are still in love with the company.
Don’t sell short
Do you feel that penny stocks simply aren’t risky enough? Do you want to add yet another layer of riskiness on top? Then go ahead and short-sell penny stocks that you think are subjected to a pump and dump. This is very risky.