How to Invest in Penny Stocks

Investing in Penny Stocks

Penny stocks are a very peculiar type of investments. They unite shares issued by thousands of companies across the world for their shared quality – cheapness. As the name suggest, penny stocks are low-cost shares, mostly below the value of 1$ per share. Because of this defining feature, many beginners choose to invest their money into one of these assets.

If the share pays off, an investor receives profit, if it fails – they don’t lose too much. It’s a very tempting offer, but the practice of penny stock investing isn’t that easy and profitable as it may seem at first.

The disadvantages of penny stock investing

Apart from the practical disadvantages associated with the process of investing itself, there are several fundamental flaws that might turn you away from investing into penny stocks.

First of all, the reason why these shares aren’t too costly is because the companies that issue them are either not very valuable themselves or nearing bankruptcy. Additionally, most of these companies don’t have a very extensive financial history, if any at all. The worst case scenario, they are just scam.

Secondly, if the share is so obviously cheap and not backed by any legitimate company, then it won’t have too much liquidity (i.e. demand). The penny stock trading may be a fairly popular niche, but there are simply too many of these companies. You may spend some days before you can sell it at a favorable price (if sell at all). That’s why it’s very important to pick your issuer accordingly.

How to get into penny stock trading?

Legitimate exchanges don’t often support the penny stock brokering, most of the time the issuers don’t want to or simply can’t pay for keeping their license up.

Instead, most investors simply use OTC (or over-the-counter) markets. These are different from your everyday asset markets, they are basically auction houses where two parties – investors and brokers – interact with each other and conduct deals. There are a lot of such markets, so there’s always a fine assortment of partners to trade with.

Each broker hold a number of hand-picked assets, including the penny shares in some cases. Picking one of the brokers with the assets that suit you most is the hardest part of this task. However, it helps that you can see both the contents of each broker’s portfolio and the qualities of each asset type.

In most scenarios, you can also view such crucial trading elements as fees structure and commission amounts. As on the usual markets, you’ll have to pay extra in order to trade with brokers. There are many different types of fees: per-deal, per-share, and more. Often the choice of broker requires no less research than the choice of the issuer.

The disadvantages of OTC

If by circumstance you’re required to use OTC to invest into penny stocks, you may need to consider flaws of such systems. There’s quite a few of them.

The lack of liquidity is one such flaw. The penny stocks are already very modest in terms of liquidity – the proportional liquidity of OTC is staggering. These markets don’t only let people trade in stock, but also in bonds, currencies and even commodities.

However, the overall supply outstrips demand by a large margin. That’s why, even though penny trading itself is a very prominent niche, the percentage of penny assets actually involved in deals of any sort is very humble. In short, not only do the shares lack liquidity themselves, the markets where you can find them themselves don’t inspire much liquidity.

Additionally, over-the-counter markets are much less safe and secure. The platforms themselves may be full of fraud, for one. Plus, there’s always a risk that both the shares you trade in and the brokers you trade with will become defunct in some capacity.

It gives you some idea of how risky investing and trading in such stocks may be. What’s equally important is that you’re pretty much obligated to use these stocks on these OTC markets, the fact that only increases the risks.

How to invest in penny stocks?

You’ve most likely picked your issuer before you even found out anything about penny stocks and over-the-counter markets. However, if you didn’t and if you don’t want to go through an enormous variety of shares on your OTC platform of choice, you can use a simple procedure called stock screening.

Screening allows you to narrow down the list of shares into a neat variety of assets that share the qualities set by you (for instance, the price of <1$). Once you’ve done it, you’ll be left with the number of active issuer companies and the prices of their stock per one share.

If the software allows, you can add other variables, like the supply, number of recent deals, etc. It’ll help drastically. You need to remember that liquidity issues true for every penny stock issuer.

Research

But of course, the choice must not stop on some issuers simply because they have a good supply and high liquidity rates. You should take into account the usual properties of shares, as well as specific qualities of low-cost assets.

  • Volatility

Volatility is always a measurement you need to keep an eye on. Volatility represents the instability of value. Volatile assets are generally more prone to suddenly drop (or rise) in price. You may think that it shouldn’t be important if your shares are cheap and expendable.

But if, say, you purchased 1000 shares of toy-making company, 0.50$ each, your total wealth in investments will be 500$ (ignoring all the other assets you might have). Now, imagine the price suddenly drops by 20% overnight – this will cost you roughly 100$. It happens a lot – to people who pick volatile assets hoping for quick profit.

  • The financial safety

Conduct a small research of your company’s financial safety. The risk of bankruptcy of some financial catastrophe is all too familiar for penny companies. If the company goes bankrupt, even your small-cost assets will probably go to waste.

  • Trend

Remember that penny investing implies short-term trading, even though it may not always be an option. In the ideal environment, you’ll have to make the trend of asset is up to your expectations. For instance, if you hope for a long position, make sure that the trend is climbing, and so on.

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