Penny stocks generally refer to shares of stock that trade for less than $5 through an over-the-counter service like pink sheets or over-the-counter bulletin board. Penny stocks are often shares of new, unproven companies with high potential for gains and losses.
Penny Stock Basics
Penny stocks are a high risk, high reward investment. If you buy into a stock that only costs 10 cents a share, an increase of 1 cent in the price nets you a 10 percent gain in your investment. On the other hand, a fall of a penny will result in a 10 percent loss. Before buying any penny stocks, you should understand the dangers of investing in high-risk investments and be aware that there is a good chance you will lose the majority of your money. Penny stocks are also susceptible to fraud, since large investors can dumb a lot of money into a certain stock, raising its price rapidly and attracting attention to it, sparking more investment, only to dump all of their shares, pulling a profit, while latecomers end up losing money. Considering the risk, it is wise not to allocate a large proportion of your money to penny stocks.
Buy Active Stocks
Penny stocks don't trade in volumes as large as big reputable companies on the New York Stock Exchange, but some trade more frequently than others. The last thing you want when buying a penny stock is to be unable to sell due to low trade volume. When you look at the quotations for penny stocks, pay attention to trade volume and favor those with higher traffic that you will be more likely to be able to buy and sell when you want to. If you are stuck with a stock that no one will buy, you might never get your money back.
Know Your Stock
An important part of investing in a company is understanding the business itself and the value it produces to judge its likelihood for success. While investors may not put too much effort into researching well-established companies such as Walmart or Target, knowing what a penny stock company does will help you understand your investment. If you don't understand the purpose of the underlying company, you should not invest.
Make an Exit Strategy
Penny stocks should not be viewed as long-term investments. When you put your money in a penny stock you should make a plan as to when you will take your money out. An easy way to decide when to take out your money is to set limits as to how much money you will allow yourself to gain or lose before dumping the stock. For instance, you might decide that if the stock drops by 20 percent, you will get out, while if it goes up by at least 30 percent, you will cash out. Setting limits will help you stop excessive losses and realize gains.