Trading penny stocks is considered a risky business for many and there are reasons why this is true and reasons why it is still a good option for making money. Experts define penny stocks as company shares below $5 each. Even though beginners start trading with these cheap stocks, they experience the volatility and risk immediately. However, before you start investing, take heed of these common precautions to start trading in a prudent and reasonable way.
Trading in itself is a risky proposition, trading in penny stocks is more so. Low liquidity, dependence on momentum and manipulative nature makes penny stock trading a riskier option than normal stock trading on stock exchanges through your broker.
I always feel penny stocks are not for long term holding. It’s perhaps riskier to have a buy and hold strategy for penny stocks. Your investment might lose all its value down the line if the company goes down. But that’s just my opinion.
(Must Read – How to control stock trading impulse)
Precautions before trading penny stocks
Some of the precautions are same as with any general stock trading precautions. I am going to list some of the precautions that are uniquely associated with penny stocks.
To start off, understand the basics
Some of these basics include understanding that there are risks involved. Risks come in two ways,
- First, companies in the penny stock trade are not required to disclose as much information like those listed on the exchange.
- Second, the prices are volatile and are prone to rising or dropping abruptly. You should always be comfortable with what you invest.
Gather as much information as possible
Since penny stocks are not traded on the stock exchange, they don’t necessarily file with the SEC, meaning they are not openly analyzed. This gives us little information to work with. Meaning you are betting on stocks based on other factors. You will need proper information and history of the company to make proper judgment.
It is important to do a background check on a stock before buying into it.Here’s a guide from SEC that tells us what information to obtain before investing in penny stocks.
Low liquidity of stocks
Penny stocks have low liquidity and prove difficult to find a buyer for. This becomes less enterprising when you have to lower the value to match buying price, rendering it impossible to make a profit.
You can’t trade penny stocks on major stock exchanges. Rather, penny stocks are traded over the counter, listed on Pink Sheets and the OTCBB. This makes penny stocks rather unique to other common stocks, and somewhat harder to find a buyer when you want to sell your stocks.
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Stay away from hype
The first thing you need to do is stay away from the hype that constantly erodes the market. Approach every trade with caution to avoid buying into a scam. I am enrolled in a newsletter that exposes such penny stock hypes. You can think about subscribing to this news letter if you want to trade in penny stocks.
You may run into unsolicited junk faxes and hyped up press releases urging you to buy. They come from promoters who are out there and their main objective is to puff up stocks claiming they promise explosive gains. While a stock potential to thrive is always there, do your homework first. Information is your most reliable tool and if you can’t match the hype with actual data just ignore it.
You are also likely to get calls that pressure you into considering low-priced stocks. Ignore them and hang up. This is a common practice that can influence your judgment into buying valueless stock. Get your daily dose of information from a trusted broker and don’t listen to strangers.
Focus on finding good stocks
Sometimes there are stocks from decent companies and are under the radar from everybody because they are either undervalued or new. Focus on finding penny stocks to invest. Hold them until the company gets a positive turnaround and find a buyer. Do not invest too much in a single stock as the risk becomes higher.
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Don’t get attached to a stock
Sell upon finding a buyer and avoid hesitation either because you are attached to a certain stock, or you are too greedy. There is a reason why a stock maybe under the radar so if it starts to rise, why hold for longer? Getting attached to a certain stock is the last thing you want to do. After all you are in it to make a profit.
To many trading penny stocks is too risky, yet there are people who made huge profit by trading penny stocks. People get attracted to it as a few $ of price increase mean doubling or tripling entire investment dollars. To those trading penny stocks is not that risky. There are people generating steady income out of penny stocks.
As a buyer and investor, you should make proper decision and choice based on your need and your risk tolerance level.
Readers, have you traded in penny stocks or are you planning to trade a few to test the water? What risks you may have faced by trading penny stocks?
Thanks for posting! I actually have some penny stocks that I was planning to trade – this post made me think twice!
Be cautious though. and do your thorough research
Jon @ Money Smart Guides says
One of the things I’ve learned is how people tied to the stocks can influence the prices by issuing “news stories”. Since so few analysts follow these stocks, it’s easy to get a story out and have it gain traction. If you are thinking of investing, you need to treat news stories not on the company website with suspicion.
I’d add on to it, that you can keep your eyes and ears open by following stories at a genuine media publication like news papers. Company websites don’t usually publish troublesome news, which are life line for the investors.
[email protected] says
Great tips SB! I never thought about the low-liquidity aspect, but it definitely makes sense, especially if that penny stock is plummeting to near-zero values. I used to love penny stocks since even a slight change could potentially earn a large sum of money. But, the same is true for slot machines…
Nice analogy, slot machines and Penny stocks, huh! No I don’t think penny stocks are as blind as slot machines.
Great tips! I’ve never been too interested in trading penny stocks. I know some people are pretty successful at it, but I just don’t trust myself to keep my emotions out of it.
Good you are that way. If you’re not comfortable with this then stay away. Many more made profit out of trading general stocks.
jessica smith says
This Article is very useful. A penny stock or penny share is the one that trades in a very small value of a current. Its price can be 1 US dollar, 1 Euro, or equivalent amount per share in your domestic currency. Low investment, in other terms, can be said as the stock is highly speculative.