Penny Stocks 101
Research Pays Off
The penny stock market is an exciting, and highly profitable way to make money and grow your portfolio in ways the large cap market cannot compete with. Gains of 100%, 500% and on a regular basis, 1000% are common when trading hot penny stocks! It happens every day, several times a day.
However, as you have probably heard and possibly experienced, it is not as easy as it sounds. The penny stock market is rife with scams, “pump and dump” schemes, and highly risky ventures which will most likely never make it out of the starting gate.
It is for this reason you need to arm yourself with knowledge in this arena. I hope this article puts you in the right frame of mind, and prepares you to make better, more informed investment decisions.
What Are Penny Stocks?
Such a simple, yet important, question which so many overlook. What is a penny stock? Why is it a penny stock?
First and foremost, a penny stock is a public company whose shares typically trade at less than $1.00 per share. There are three general categories that penny stocks fall into.
1) Fall From Grace. A company which has recently fallen from grace or run into some form of corporate problems causing its stock to tumble from lofty heights down to penny’s. Enron is an example of this. It is generally a good idea to avoid companies like this unless a) you know what you are doing, b) you wait until the company demonstrates a turn-around - you might pay higher for the shares, however a proportionate amount of risk has been eliminated, saving you from huge losses.
2) Start-up. These are the companies which carry the most risk, and the highest reward potential. A company has come up with a new idea, a variation of an established idea or an innovative service. Or perhaps the company’s founders simply believe they can do a better job at “X” than the current market leaders. In any case, start ups are rife with risk in the sense that they are literally starting from Ground Zero, with no marketing, limited amount of cash, and a highly varied level of business experience. Researching these companies takes a great deal of effort, if you want to avoid the pitfalls so prevalent in this area. However the rewards can be significant. Finding and putting your money down on a winner can result in netting you 5, 10 or 20 times your investment in a short time frame!
3. Established small business. This business has been around for some time. A year, two years, maybe five years. Most of these companies remain small due to managements inability to compete, to expand, and mostly to raise capital and awareness to a point where they can continue growth. Like start ups, these companies are a dime a dozen, so to speak. As such, again, it takes a great deal of time and research to dig through thousands of listed companies and come up with a short list qualified to bring serious return on investment.
Finding the right penny stock to invest in is not dissimilar to looking for a needle in the haystack; or finding a diamond in the rough; simply because there are thousands of publicly listed companies vying for your attention and investment. Researching each one simply demands too much time and effort. It is for this reason you choose to follow a penny stock newsletter with the experience and depth of industry knowledge to guide you to the right companies.
Penny Stock Newsletters
As you may have experienced, there are literally hundreds of “penny stock newsletters” out there. The majority are nothing more than “tout sheets” or “pump and dump” letters, drawing thousands of investors in through well paid advertising, then selling these investors a story which has 1 in 1000 chance at actually becoming a success. Most of these newsletters get paid in shares or cash to tout a company. In essence there is nothing wrong with this concept, and you should not dismiss a paid newsletter as “hype” without looking at who is running it and why they are getting paid. The newsletter is providing a service to the public company - the service of exposure to new investors, which are the lifeblood of any penny stock. You can look at is as advertising dollars. While it is important to keep in mind whether a newsletter is getting paid or not, do not let this distract you from the profile itself; you may be looking at a big winner.
What you need to watch out for is the newsletters that caters not to the reader, but to any company willing to pay for a 1-day or 1-month advertising campaign. These newsletters typically leave readers in the dust, “pumping” a stock up through hype, then forgetting about the company a week later leaving the stock to come crashing back to the levels where it started; usually resulting in large losses for the general readership. Does the newsletter profile ONLY company’s who pay them? <RED FLAG> Does the newsletter engage in hype and fear? <RED FLAG> Does the newsletter ignore the risks inherent in various companies and industries? <RED FLAG>
Before joining a newsletter, be sure to look at its track record (if one is listed). Do they feature unpaid profiles? If they do, it is likely they actually conduct their research and pass on the good stuff to you, the valued reader, rather than punting junk your way just to pay their own bills.
Penny Stock Rockets will at times receive payment from its clients, and payment will always be fully disclosed at the bottom of each report where it applies. The difference between PSR and other tout sheets is that we approach the company after fully researching them and coming to the conclusion the company provides a reasonable chance at explosive profits with limited risk. We will profile a company only if our two decades of penny stock investing experience tells us there is real potential involved. With us it’s not the other way around, where a company desperate to unload stock to an unsuspecting public will pay handsomely a pump and dump service in hopes of generating enough liquidity to sell their position quickly, before leaving the party for good.
Due Diligence - RESEARCH, RESEARCH, RESEARCH.
The amount of research conducted on any penny stock directly correlates to the amount of success you will enjoy in your investments. A good penny stock newsletter will not only educate you and prepare you for penny stock trading, it will add to your research arsenal and help you separate worthless investments from worthwhile ones.
Stocks listed on the Pink Sheet market don’t have to file annual or quarterly statements, and there is very little regulation currently in place, therefore those companies offer the highest amount of risk; at the same time they offer you a very real chance at making 5 to 10 times your money within days or weeks.
Stocks listed on the OTC BB file annual and quarterly statements. This provides some measure of financial success. You’ll find most penny stocks initially lose money, whether through managerial incompetence, or research and development. The key is to identify the companies whose management has a record of consistently making money, or at the very least, delivering on their business plan, and decreasing expenses.
Other avenues of penny stock research include public forums, but these are to be taken with a grain of salt as these forums are typically breeding grounds for pump and dump schemes. There are very few forums which focus on meaningful research and unbiased information; however this can still be found. Again, it takes time and effort.
Volume
If you want to make money, you have to be able to buy and sell enough shares to lock in your profit, or protect your capital. If ABC company’s daily volume is only 500 shares a day, it may take you several days to accumulate a position worth taking. If there is bad news, who is going to buy your shares? If the average 3-month volume is low, this is a red flag and you will do better to stay away, unless you are completely comfortable in a) the business, b) managements ability to deliver and c) management’s ability to get the word out in order to increase liquidity. When an illiquid stock suddenly starts trading large volume, this is an indication that you are about to make some serious money. The earlier you are in, the more of a chance there is you will make a significant profit. If you are very serious about a deal that is currently illiquid, it may be worth your while to contact the company directly and work out a deal. From time to time, PSR may offer its readers opportunities to participate in company financings used for the purpose of advancing a solid business plan. When these work out, they work out fantastically.
Buy the Company, not the Hype
If you buy into hype, chances are you will end up losing - unless you are an experienced trader who can get in and out quickly enough to lock in a decent profit. By comparing their business plan with actual results, you can quickly evaluate whether management is serious in advancing the company as opposed to promoting their stock.
Size matters
There are thousands upon thousands of penny stocks; and as we mentioned most of them are not worth your time or investment. Once you have a short list of potential investments, you need to determine just how much money you want to risk on managements ability to perform. For beginners, the size of your position should not be anymore than $2000 - $3000. While this may not seem like much, keep in mind that its not unusual for a $0.10 company to drop to $0.05. That’s a 50% loss. A $10,000 position in such a deal drops to $5000, sometimes overnight. However if it works out, your $2,000 can quickly turn into $10,000 or $20,000, allowing you to lock in significant profits then roll a higher amount into the next solid deal.
Strategy Matters
You have your reason for buying a company. You have determined how much you want to risk on this plan. The biggest factor separating successful investors from those who lose time after time is the Exit Strategy. If things start going sour, at what point are you willing to accept you were wrong and cut losses? Do you have a “stop loss” strategy in place? Are you disciplined enough to cut and run, no matter what? Too often, an amateur will hold a stock as it bleeds to death, resulting in a significant loss; simply because they did not have an exit strategy in place or their ego got in the way of making a prudent “cut and run” decision.
Have Fun, Make money.
Penny stock investing can be profitable. Remember, you are taking larger risks than you would if you were purchasing shares in a blue chip stock. That risk can be rewarded with returns that you cant get with a blue chip stock, or, it will be met with a large loss and a bad taste in your mouth for investing in penny stocks. Conduct your research, follow the newsletters that deliver, play with money you can afford to lose, protect your capital with prudent exit strategies. Following this simple advice will get you far ahead of the average investor, and will eventually make a meaningful positive impact to your portfolio.