Looking to get into investing? Penny stocks are on the rise and for good reason. They are a great place to start as a beginner investor because you don’t need thousands of dollars to get started. Penny stocks have the potential to transform a portfolio quickly, with possible returns on investment of 180% and upwards. As an experienced investor, making money off penny stocks is possible.
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However, penny stocks are not a get rich quick scheme and it is important to educate yourself on the risks and rewards before you start investing. Learn how to best make money in penny stocks by following these 10 important rules.
10 Rules of Penny Stock Investing
1. Beware of the Pump-and-Dump and Other Scams
These scams occur when investors promote and endorse a stock through email campaigns, newsletters, even phone messages that seem accidental. Once the stock has been pumped up as a result of the endorsement, the investors sell the stock causing it to crash. Since companies listed on the pink sheets are not required to file with the SEC they are less regulated than major stocks and more susceptible to this scam. A good way to avoid this is to always do your own research on the stock! Although it may sound cliché, when it comes to investing, if it's too good to be true, it probably is.
2. Focus on Underlying Business
‘Shell companies,’ as they are called in the stock trading world, can be virtual goldmines for scammers. It’s much easier to pump and dump a stock that belongs to a company with no operations, since you are essentially offered a blank slate. Therefore, when looking for legitimate penny stocks, try to find those that belong to a company with sustainable business. They won’t always be guaranteed, but they’ll definitely bring you one step closer to making money in penny stocks.
3. Keep Track of Your Every Move
Getting into penny stocks for beginners can be made easier by keeping track of your trades. Set up a journal that details what moves you made, what size positions you took and whether you had a profit or loss on the trade. If you want to become consistently profitable, this journal is an invaluable resource for you, and with programs like Profitly keeping track of your every move is simple.
4. Focus on Penny Stocks With Solid Earnings.
Even though penny stocks are less regulated the SEC does require them to add disclaimers at the bottom of any email or newsletter. There is a difference between stocks making a 52-week high based on an earnings breakout and stocks making a 52-week high because three newsletters picked it. Usually you can find any conflicts of interest in these disclaimers. By focusing on the 52-week high based on an earnings breakout you have more of a chance to ensure this is a profitable penny stock with solid earnings growth.
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5. Look at the Financials
When it comes to penny stocks, the company’s financial statements are a valuable resource in deciding whether or not the stock is worth trading. The quality of the statement will tell you a lot about the penny stock you are considering. Were they filed on time? Who audited the company behind the stock? Do the financials seem sound? If the answers to these questions are positive chances are this is a more profitable stock.
6. Don't Short Sell
Shorting pumped-up penny stocks may seem attractive but penny stocks are too volatile, unless you are a seasoned professional, short selling is a bad idea. If you end up on the wrong side of the trade, you could easily lose 50% or more. Furthermore, it is difficult to find shares of penny stocks to short, especially those that made huge moves because of the hype and newsletter tips we discussed in rule number one.
7. Limit Share Size
Penny stocks are volatile and if you want to earn money you may need to get out quickly. Limiting your share size is a great way to get out of a stock faster. Stocks that are trading less than 100,000 shares a day and are under 50 cents a share usually have very limited liquidity.
8. Don’t Get Greedy
Many investors insist on getting a full 1,000% ROI or more. But in the world of penny stocks, what quickly goes up comes down at similar breakneck speeds. If you hit an ROI of 30 or even 20% avoid unnecessary risk, take that profit and get out.
9. Don’t Buy Into Hype
Don’t believe success stories touted in emails and on social media websites. Free newsletters are not giving you tips out of the goodness of their heart. Companies want exposure, so almost all newsletters make false promises. Every penny stock company wants you think it has an exciting story that will change the world. If you enter the penny stock game, be cynical and always, do your own extra research.
Even if friends or family members are touting a particular stock don’t put all your eggs in one basket. One interesting way to diversify is by investing in penny stocks that pay dividends. A good method for finding such stocks is to filter for them via free online screeners, such as Fool.com, Google Finance, or Zacks.com. Keep in mind dividends alone won’t make trading penny stocks profitable, but they can help reduce the margins of your loss.
The most important lesson to remember if you want to make money on penny stocks is stay informed. Seek information from multiple sources including other investors, credible websites and newsletters. Don’t buy into hype and don’t expect to get rich quick. With high reward comes high risk and penny stocks are the perfect example of this.
It is absolutely possible to make money on penny stocks as long as you have the right expectations. Timothy Sykes, one of the most successful penny stock traders, says he tries to make just $0.50-$0.75 a share with each trade. If you’re trying to chase big wins, you will force trades that aren’t really there and these kinds of mistakes will take you out of the game before you even have a chance.
For more information on penny stock trading, check out our comprehensive guide. Good luck and happy investing.
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