Learn How to Get Started In Penny Stocks

penny stocks trading on the stock market
••• Paul Falardeau

If you have the desire to invest in stocks but don't want to risk a large amount of money, you can get started in penny stocks quickly and simply. It's easier than you think, it can be quite fun, and you might even make some serious profits as well.

Of course, there are risks, as with any investment. The first step is to learn about and avoid these dangers and preserve your capital. You can learn fairly easily how to sidestep the pitfalls while focusing on low-priced investments that have the potential to increase dramatically in price.

Success with penny stocks comes down to understanding that stock market investments are simply shares of ownership in the underlying companies, and certain companies operate in a way that creates increasing value over time. When those companies do well by increasing revenues, capturing more market share, or growing in size, their share price often follows suit by increasing as well.

Investing in penny stocks is actually very similar to buying stock in a massive company such as IBM or ExxonMobil. It's just that the share price is lower and usually more volatile, and often the company which the penny stock represents is much smaller, newer, or yet undiscovered by other investors.

If you know what to look for to find the great companies which are still trading at low share prices, your investment dollars can multiply many times over. Then, if and when the share price moves higher, you'll experience the rewards of your due diligence and wise investment.

What Are Penny Stocks?

Penny stocks are stock shares that trade for $5.00 each or less. Actually, a lot of multi-billion-dollar companies fall into the penny stock category. Ford Motor Company for example, was trading for $1.87 per share after the 2008 financial crisis.

There are plenty of other companies which are or were technically penny stocks, and many of them are names you might know. Often, they are large corporations on their way up (along with their share price).

Many of these penny stocks are traded on the major exchanges such as the NYSE, American Stock Exchange, NASDAQ, and the Bulletin Board. However, there are also smaller, more risky penny stocks which trade on "dark" markets such as the Pink Sheets, OTCQX, and OTCQB.

By avoiding the dark markets, and instead focusing on the high-quality companies which trade on the major exchanges, you will have already better positioned yourself to make some profits (while avoiding losses). Stick to the best markets, do some research and avoid those people offering "free stock picks."

Beware of Potential Scams

You have probably heard a few things about scams and frauds in penny stocks. The thinly traded nature of most of the penny stock companies, plus their tiny size in some cases, affords dishonest players the opportunity to try to make money for themselves by attempting to manipulate the prices of the penny-stock company's shares.

The people who are vulnerable to such scams are those who spend money to get a free stock pick they hear about, whether through an online message board, the postal mail, or a free newsletter. They get taken in by the dishonest hype a scammer gives them about a certain company, believing it and unknowingly investing their hard-earned dollars into a worthless company's penny stock.

It is NEVER a good idea to buy a penny stock that a promoter is talking about. No high-quality company ever needs a promoter to try to drive its stock price higher. Companies that are worth your investment will increase in size and price on their own.

Why Penny Stocks Have a Bad Name

Penny stocks have earned a bad name in some ways, with the majority of the negativity coming from people who have been burned by scams, as well as those who were fooled into purchasing low-quality companies. By learning how to research companies and focusing on ones with high-quality operations, you have the chance to turn a small investment into something much more significant.

Protect yourself by avoiding free stock picks and the dark markets, and focus on high-quality companies to dramatically increase your odds for investing success.

By choosing to invest in low-priced companies when they're turning the corner and their business operations are starting to pick up momentum, you may see their share price rise pretty significantly and dramatically. If you can buy stocks that do this a couple times in a row, you've turned a small investment into something greater, something which could have a major impact on your life.

Getting Started: Practice First

Before jumping right in, test out your investing strategy in a way that lets you see how you'll do without risking any actual money.

  • Step One: The first step to investing in penny stocks very well is to do nothing. That's right, do nothing. Before you start investing real money and potentially taking losses, start by paper trading. Keep track of real stock movements with imaginary money investments, and see how you would have done if you had traded actual dollars. If you would have lost money, then you wind up having saved yourself those dollars. If you would have made a profit, you now know that you are doing things right. Nest, apply your winning techniques to trades with real money, and you have the potential to watch your dollars grow.
  • Step Two: Find good penny stock companies yourself, or get some guidance from an authority who has done the research. This is different from someone offering free stock picks. A reputable authority is someone who gives the pros and cons of different companies, letting you make your own decisions on where to invest, without having to listen to any hard-sell or persuasive tactics.
  • Step Three:  When you begin investing, you will want to learn how to make the right kinds of trading decisions. Fortunately, there is plenty of information on the Internet about different ways to trade stocks, and how to buy and sell penny stocks specifically.

    It pays to learn how to invest properly, no matter how long it takes, because the market will always provide plenty of opportunities for you. Unfortunately, if you rush things and make mistakes, or have sloppy trades, you will end up with no money pretty quickly, and probably feel discouraged as well.

    The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.