For the investor willing to risk it all to make a fortune, penny stocks can be the way to go. Penny stocks are available in the stock market for under $5 a share. The low price typically is due to the status of the company in which you are investing. Some stocks become penny stocks as a result of a company hitting a rough patch. Other times, penny stocks are tied to smaller companies, or companies that simply are new.
Whatever the case, penny stocks are generally riskier than regular stocks. But with this risk comes the potential to make a fortune. Some experts know how to invest in penny stocks, and you can put their tips to work. Following are six important steps to take with this kind of investment.
1. Don’t Go Too Low
“Fact is, it’s far more likely that you lose money in the ‘under a dollar’ cohort rather than make money.” — Jim Cramer, investing expert and host of “Mad Money”
The admonition to avoid going too low amounts to Penny Stocks 101 and one of the oldest rules associated with this form of investing. Don’t invest in truly unknown, three-employee companies.
When a penny stock is listed between $1 and $5, there is likely some stability surrounding it. Perhaps the company has a decent-sized workforce, and one bad week will not make the company fold.
However, when a stock is under $1, steer clear of it. Companies typically are in this range if they are highly volatile or are about to fold. Either way, it’s a good idea to avoid getting involved.
It is rare for a very cheap stock to go up exponentially. Don’t put thousands of dollars into penny stocks in the hope of finding the new VirnetX, the internet security company that went from 21 cents to $22. That type of growth isn’t typical.
2. Don’t Believe the Company Management
“You can’t trust anyone. The companies are trying to get their stock up so they can raise money and stay in business. There is no reliable business model or accurate data, so most penny stocks are scams that are created to enrich insiders.” — Timothy Sykes, expert penny stock trader
You should not trust companies whose stock you purchase. Due to the somewhat under-the-table nature inherent to many penny stock investments, there is no way to ensure the company is being honest.
The Securities and Exchange Commission has to impose special rules on the penny stock marketplace, and goes to extra lengths to control that marketplace. Thus, be cautious about treating what these companies say about their stock as fact.
Be wary of possible pump-and-dump scams, in which misleading statements are used to pump up the value of a stock. Penny stocks are not always an honest business, and you will get burned if you treat them as forever forthright.
3. Know the Price You Are Paying
“When buying an over-the-counter stock, otherwise known as a penny stock, you must be sure to protect yourself and make sure that when you place an order to buy or sell, that you put a specific price on it.'” — Jeff Rose, certified financial planner
As a whole, the over-the-counter markets — also known as OTC markets — are fairly dishonest places. So know exactly what you are paying before you make a deal.
Since many penny stocks are not officially listed on the market, there is no price for them that you can prove. So before you agree to buy particular penny stocks, find out their value and make sure you buy the stocks at those prices.
Neglect to do this, and the broker might raise the price to whatever he thinks the stock is worth — or whatever he feels like valuing it at.
Related: 10 Good Investments for Risk-Takers
4. Always Be Wary of the Risks Involved
“Penny stocks are the long shots of the investing world. For every one that pays off big, there are many, many more that don’t.” — Jeffery Born, professor of finance at Northeastern University
Be aware of the high risks involved in penny stocks. Do not invest expecting to be the next big penny stock trader who will make a 1,000-percent profit in two weeks. Instead, look at penny stocks as a high-stakes, high-risk gamble.
Remember, it’s difficult to make money in penny stocks, due in large part to the lack of data and stock analysis available on the companies offering the stocks.
5. Take a Short-Term Approach
“Yes, it is always tempting to hold on to a pick in case it’s the next 1,000-percent runner. Sometimes, by selling early you feel like an idiot a couple weeks later, as you could have made two or three times as much.” — Timothy Sykes, expert penny stock trader
Penny stocks are not the same as blue-chip stocks or bonds. You can hold on to those latter two investments for years. By contrast, you do not want to keep a penny stock for any longer than a week or two.
A penny stock company can fold if it goes through a rough patch, so it is vital to sell before that happens. So regard all penny stock purchases as short-term investments.
As soon as there’s a short squeeze and a noticeable profit to be made, jump out of the stock. Don’t wait for the next massive jump in price because it probably won’t arrive. With penny stocks, simply accept a small return and duck out.
6. Keep a Long-Term Mindset
“If you just want a quick hit that turns your $132.44 into a million bucks overnight, then you have already lost — you are in the wrong place.” — Peter Leeds, financial analyst
Developing a long-term mindset is among the most important things to remember about penny stock trading. This type of investing is a process — one that will take a while. You won’t get rich overnight.
Through training and getting smarter and smarter in the penny stock market, you can gradually make bigger and bigger returns.
Penny stocks are a gamble, but they are not a slot machine. If you make money, it won’t be instant. Many people disregard this fact and get discouraged after a bad first few weeks. If you plan to get involved in penny stocks, don’t give up easily. Investing in penny stocks is a skill to be learned — and one that takes time.