Are Penny Stocks Appropriate for You?

Penny stocks can be rewarding, but are they appropriate?

••• kmlmtz66/iStock

Are penny stocks appropriate for you?

While that's definitely a loaded question. Only you can truly know whether or not penny stocks are appropriate for you, but there are certainly many different arguments on either side of the coin.

Penny Stocks Are Riskier​

Penny stocks are very risky, more volatile, and typically represent smaller or newer companies which can be derailed by a myriad of obstacles. However, they also present the opportunity for making significant profits over short time frames.

You need to do a bit of soul-searching to decide whether or not it's appropriate for you to be trading penny stocks at all. Don't be afraid to admit if these ultra-low-priced investments do not fit in well with your portfolio or risk tolerance.

This is probably best left to a discussion with your financial advisor, but just to save you the time and effort it would take to ask them, I can already tell you what your financial advisor will say:

"Penny stocks are too risky, and not appropriate for anyone to purchase."

There Is a Right Way to Invest in Penny Stocks

However, what your financial advisor does not understand is that there is a right way to go about investing in penny stocks and a wrong way. By going about things properly, you significantly decrease the risks, while opening up your portfolio to some very impressive gains.

In fact, some of the greatest companies in America started out small as penny stocks, and have now grown up to become household names. During this growth, these companies have significantly enriched their shareholders.

If you focus on high-quality penny stocks, which in our view represents only about 5% or less of the total low-priced options which are out there, then you significantly increase your odds of finding a company which will balloon in price. Remember, the purpose of a business is to make money, so we need to find those penny stock companies which are making money, or setting up the potential to bring in a lot of revenues.

By avoiding the riskier and low-quality companies, such as the thousands and thousands which are listed on the pink sheets and dark markets, you significantly increase your odds of finding a winner. Also, by avoiding any penny stocks which you heard about for free (because there are hidden motivations behind free stock picks), then you are in a significantly improved situation to potentially profit from penny stocks.

Learn How to Trade Penny Stocks

The best way to proceed is to learn how to trade penny stocks before you ever risk a single penny. We personally always suggest that people begin with a paper trade. This is a method of tracking real stocks, but only investing in them with imaginary money. In this fashion, you can see how your trading choices would have played out, while you are learning about trading penny stocks.

After that, if you do decide that the world of high-risk, high-reward penny stock trading might be appropriate for you, then make sure to proceed in a smart fashion. Learn what you can, buy what you know. Don't rush, and as always, keep your emotions in check so that you can avoid making rash or impulsive decisions.

Penny stocks are fun and challenging and rewarding. In my own personal opinion, penny stocks are appropriate for at least a small portion of everyone's portfolio. There is no better way to learn how to become an incredible investor by being engaged with the most volatile and small companies which are on the stock market.

All of this is predicated, of course, on the understanding that you took the time to learn how to avoid the risks while understanding the underlying company and their business model.