10 Penny Stock Tips
For anyone interested in trading penny stocks, there are important tips which you need to know. Let's start with the simple stuff, and work our way up to the surprising and super-important aspects.
The content below is divided into three major sections: protect yourself, learn, and trade. Even very experienced and practiced traders will find much they can benefit from the more advanced tactics, which are reviewed in the final parts of this article.
However, all the content will also be very helpful to new penny stock investors.
Avoid Low-Quality Markets
There is a wide range of stock markets upon which penny stocks can trade. However, these exchanges are certainly not all created equal. In fact, keeping to the "good neighborhoods" is one of the most effective methods of avoiding the risks of low-priced shares, while dramatically improving your potential odds of success.
Considering that penny stocks are any shares which trade for less than $5, there are plenty of penny stocks on many of the major exchanges (like the NYSE, the American Stock Exchange, and the NASDAQ). There are even a few which trade for less than one dollar but still trade on these "big-board" markets.
However, you will typically find most penny stocks trading at the following locations:
The Bulletin Board (OTC-BB)
This is owned by the NASDAQ, and as such has listing fees, standards, reporting requirements, and the companies trading upon it have a responsibility to provide the shareholders (you) with timely financial documentation.
Higher-quality penny stocks list here when they are just shy of attaining the status which comes with the NASDAQ or NYSE.
The Pink Sheets, OTCQX, OTCQB
These are the main junky markets and are very dangerous to all penny stock investors. As the fees, reporting requirements, and operating standards have been thrown out the window, just about any business can get listed on these channels.
Even a hot dog stand, or in-home art studio, or one-man mechanic shop can be listed on these markets. Since they have such a low standard to get started, and almost non-existent fees, just about anyone can get their company on them to be publicly traded.
That is why such a concentration of very poor companies can be found on the Pink Sheets and OTCQX. The vast majority (as in over 98%) do not pass Leeds Analysis when we take a look at them. By simply avoiding penny stocks trading on these outlets, you will reduce the vast majority of downside risks, and much of the reasons which cause low-priced shares to have such a bad name.
Avoid Free Stock Picks
Penny stocks are lightly followed, and typically very thinly traded. This, combined with their super-low price per share, makes them the ideal vehicle for promoters and scam artists.
Usually, shady characters will buy up a ton of some near-bankrupt, almost lifeless penny stock, then use lies and exaggerations to push the share price much higher. They might say the company is about to get some huge business deal with Google or their neighbor just struck gold in their similar mine, or they are going to land a major FDA clearance, or whatever.
That typically helps increase the value of the penny stock, which creates a profit for the promoter or scam artist. As the shares increase in value, they sell their holdings at the artificial price which they created. This is also why the shares collapse back down to near-worthless status, once the promoter has taken their dishonest profits and moved on.
There are also other reasons for putting out free stock picks, whether on message boards, or in the conventional mail, or "sign-up-free" online newsletters. Sometimes this involves simply a lone individual who bought the penny stock and is trying to inflate the value of their investment.
However, in most cases, the actual companies themselves are paying various people or services to tell the world all about their business. It is not uncommon to have a small, publicly traded penny stock pay six-figure amounts to get the right kinds of exposure - the right kinds of exposure means the type which results in the shares getting a lift so that they can issue more stock at a better price, and raise money more easily.
Always remember, free stock picks only exist because of the vested interests of the company, or promoter, or scam artist. Watch out for ads in disguise (where the company paid for a glowing press release, which is crafted to look like real, official news).
To get over the willful blindness that many of us face, ask yourself a few questions:
- Why are they telling me about this company?
- If the business is so great, and they are going to accomplish what the pamphlet or website is saying they will, why would they need to reach out to me specifically (for my $900 investment)?
- How does buying the shares help the company at all? (It doesn't, but many people don't seem to recognize this fact).
Here we discuss preparing yourself, by learning the "rules" of the game. All of the information you need is widely and freely available, so it is up to you to take a couple minutes to review it.
By keeping track of pretend money, and making imaginary trades, you will learn what tactics work, and what sorts of penny stocks provide you with the greatest profits. The beauty is that all it requires is a pencil and a pad (and an internet connection).
Paper Trade until you consistently show profits from the penny stocks you "would have" traded. Then you can be more confident as you make the jump to real money. Now, if you would have lost on your trades, at least you didn't lose cash in real life, and ideally, you learned some things that you might be doing wrong.
100% Unbiased Guarantee
Do not rely on any site which can not point to a 100% Unbiased Guarantee. Regardless of what they call it, you only want to trust a website or service which ensures your best interests are front and center. They should commit to everyone that they will not trade in the shares they tell their customers about, and certainly not be simply touting their own investments.
Speaking of who you can trust, one of the best ways to narrow the field of newsletters and potential prognosticators is to look at who the media choose for their stories. The networks and mass-market publications have a certain level of professionalism and reputation to uphold, and so they go with the authorities.
The same can be said for many of the top book publishers, like John Wiley & Sons, who produce works like, "Penny Stocks for Dummies." Their exhaustive vetting process alone is usually thorough enough to provide you with some serious confidence in who they choose.
Of course, the next natural extension for any authority is to have some public speaking engagements under their belt. Just by dividing the prospective "gurus" between those who have been asked to give a talk, and those that have not, you will instantly weed out all the wannabes.
Finally, and perhaps the most fun portion of getting into penny stocks, if not the most important, is knowing how to find the highest-quality investments and the ways in which to trade them.
Technical Analysis Tools
There are plenty of interesting and simple online tools which can be used to improve your trading results, such as the Relative Strength Index (RSI). This is just one example from among dozens of possible technical analysis (TA) options, and you will need to discover and decide which ones work best for you (if in fact you even want to use technical analysis at all, which you may not).
You may need to paper trade to figure out the best TA tools for you and your strategy. Besides these sorts of technical analysis indicators, there are a few "tried and true" rules:
With penny stocks, beware of confirmation bias. This is something that afflicts nearly every human being, and certainly 100% of new investors (or rookie poker players). Seeing what you want to see (albeit usually subconsciously) can be incredibly costly.
Always use limit orders (rather than market orders), when trading penny stocks. The very act of buying or selling shares in a company that is thinly traded can result in the price moving due to your trade. In other words, your buy might cause the shares to temporarily and artificially increase, then drop back down as soon as your purchase has been filled.
Stop Loss Orders
Possibly the single most important tactic to investing well in penny stocks is to always use stop loss orders. Basically, you commit early on to immediately sell your shares if the price dips to a certain point, say for example down 5%.
If you stick to this self-imposed rule, you limit your downside to 5% - you will take a few very tiny losses, but at the same time be open to the tremendous upside that penny stocks often provide. As well, you may see better overall trading results by selling your losing positions very early (take them off like a band-aid), and let your gains run.
Penny Stock Tips
Overall, by observing many of the truths of penny stocks described above, you will be well ahead of the game. Much of this information took decades of trial and error to establish, and now it is all yours within minutes simply be reading the concepts above.