Penny stocks provide an opportunity to achieve huge returns. If a stock is trading at 1 cent per share, you can buy 100,000 shares for $1,000. If the stock price goes up to $1, then your investment increases in worth to $100,000. The problem is that you often get what you pay for. You can easily end up holding a basket of worthless stocks that never increases in value.
What is a Penny Stock?
A penny stock is a stock that typically has a low per-share stock price and low capitalization. These stocks often do not trade on major exchanges such as the New York Stock Exchange or NASDAQ, but trade on the Over the Counter Bulletin Board or Pink Sheet markets. Shares typically trade for less than $5 and are often thinly traded.
To identify potential penny stocks to buy, the best thing to do is to use one of the many free stock screeners available. Use the stock screener to find stocks with a price range from 5 cents to $2, daily average volume of 100,000 or more, positive earnings per share, and a 10-day moving average that is above its 25-day moving average. These settings narrow the list of potential investments to a list that only includes real, money-earning companies with enough trading liquidity to allow you to easily buy and sell shares. Additionally, the moving average screen identifies penny stocks that are in an uptrend. As of September of 2009, running this screen turned up only one company, Boots & Coots International. They provide a suite of integrated pressure control services to onshore and offshore oil and gas exploration companies around the world. With the potential recovery of the economy and the increased demand for oil, this company should experience an uptick in demand for their products. More research would need to be done before you invest, but this does illustrate the usefulness of stock screeners in limiting the number of potential investments to a manageable amount.
After generating the list of potential penny stocks, start checking the news for each one. Did something positive happen to the company? Did they get a new contract, release a new product or have a change in management? You want to try and identify the cause of the recent uptrend. Identifying the cause allows you to determine whether the company is likely to grow or whether this is just a short-term blip.
Investing in penny stocks is incredibly risky. Due to their small size, few analysts actively follow them and little information is available to an investor. Most penny stocks will either remain penny stocks or go bankrupt. Few grow large enough to make the jump to the major exchanges. To mitigate this, make sure you diversify your holdings and only invest a small percentage of your portfolio in penny stocks.