Many people who have never played the stock market game before start with penny stocks. Heck, even if you’ve been around investing for decades, penny stocks are still your ticket to triple, quadruple or even quintuple-digit gains. You just can’t see those if you bet on the Dow.
The problem is penny stocks are a bit more difficult to research than their large blue chip cousins. To make this a bit simpler for first-time investors, here are 10 things to keep in mind when looking for solid penny stock plays:
1. Think Outside the Box
When it comes to penny stocks, some of the wackiest ideas have translated into serious gains for investors who were willing to think outside the box…
Back in the day, who would’ve thought that computers were the “wave of the future”? Early investors in companies like Microsoft and Yahoo, that’s who! They made a bundle by thinking outside the box and betting on business models and technologies that were out of the ordinary.
There are new technologies and business models out there in the penny stock world today. Are you willing to think outside the box on your next penny investment?
2. Know What You Own
In the world of Wall Street, whether you’re investing in penny stocks or blue chips, one of the biggest rules is to “know what you own.” What does that mean?
You should know the company you’re investing in inside and out. Know its business. Know how it makes money. Know its management.
But as important as this rule is for any investor, it’s doubly important for investors in penny stocks! That’s because with penny stocks, share prices can change quickly if you don’t keep a handle on them.
So know what you own and your investments won’t end up owning you.
3. Don’t Get in Over Your Head
When you see a hot penny stock that’s ready to take off, it can be hard to keep from cashing out your 401(k) to buy as many shares as you can…getting in over your head with penny stocks is an almost sure way to get burned.
Even though penny stocks can make you some serious money, they’re volatile – and that means you shouldn’t put more than 10% of your portfolio on the line.
What’s the smart penny investor to do? Set up an account for just penny stocks and load it only with money you’re prepared to lose.
4. Don’t Be Afraid to Ask…
One of the beauties of penny stocks is the fact that they’re smaller companies that are out there for smaller investors.
As an individual investor, a big multinational might not give you the time of day. That’s usually not the case with penny stocks. In fact, it’s not unheard-of for individual investors to pick up the phone and chat with a company’s CEO or CFO on the spot.
If you’ve got a burning question about a penny stock prospect, e-mailing or calling the company’s investment relations firm or corporate offices might be one of the most telling ways to figure out if that stock’s for you.
5. Be a Skeptic
Remember when we said to think outside the box? Well, do that, but don’t forget to be a skeptic…
Just because a company has an interesting new idea doesn’t necessarily mean it’s a good penny stock prospect for your portfolio. The key is…Do you think that it can monetize its idea?
If that answer isn’t immediately clear, it’s time to dig a little deeper into that company’s prospects. Thinking outside the box is a great way to get innovative companies on your radar, but being a skeptic is the only way to make sure that translates into gains for your portfolio.
6. Think, Then Buy
When you’re ready to buy shares of a penny stock, make sure you take a second to think about what you’re doing. All too many first-time penny investors take the jump on just a few shares of a penny stock without realizing how much the size of their investment will affect their returns.
Think about it this way…You’re an investor who sees an attractive stock for $1 per share. You don’t have a large portfolio yet, and you don’t want to take too much of a risk, so you buy just 50 shares for $50.
Turns out you picked a winner that made 40% in just a week – $20 of pure profit. You sell and rejoice in your penny stock success. But wait…is that celebration justified?
You’re forgetting about those $10 execution fees you paid to buy and sell that stock. That’s $20 altogether. Looks like you only broke even, despite the fact that you had a stellar stock.
When you’re buying penny stocks, make sure you’re buying a large enough quantity that account costs (like execution fees) don’t eat up your profits. You can find out your minimum returns to break even with this:
Execution Fees/Stock Acquisition Price x 100 = Break-even Gain (Percent) Needed
7. Don’t Get Greedy
Lots of penny stock investors see 200%, 500%, even 1,000% gains on a stock but still end up losing money in the end. It’s not because they didn’t plan their buys properly…it’s because they got greedy!
It doesn’t matter how much money a stock makes if you’re not ready to press the button and realize those gains. That’s why you need to set solid exit points for any penny stock you buy.
It’s human nature to want to hold onto an investment as you see it climb with no end in sight, but doing that is a great way to miss out if that trend turns around. When you analyze an investment, think about a logical exit price and sell for that. Picking solid exit points will become easier as you develop your investing chops.
8. Don’t Get Too Nervous
The flip side of getting greedy is getting nervous with stocks that are seeing major gains in short periods of time. Relax. As a penny stock investor, you’ve got to be ice-cold when you see one of your picks take off.
Again, it comes down to picking good exit points for your investments. If you’re sure that your stock is bound to start losing ground before you hit that target price, maybe it’s time to re-evaluate what that price should be.
Remember, you can reanalyze your targets anytime, but you should never make trades on emotion alone.
9. Be Realistic
While investors might hope for tripe-digit gains on every pick they make, even the most seasoned pros of the investing world make bad picks from time to time. That’s why having realistic expectations is so critical.
As with picking the right target prices, knowing what kind of gains to expect comes with experience as a penny investor. It’s tricky to know when you should expect 20% from a stock and when you should expect 200%.
But setting those realistic expectations now, from the get-go, will get you into a habit that will help you structure your portfolio in a way that will get you the most bang for your investment buck.
10. Be Ready for the Next One
It’s easy to sit back and relax after you’ve just made a trade – especially if you banked a nice gain. But not so fast!
As much as you might want to bask in your investing success, fight that urge.
The secret to the penny stock game is to always be on the move. Always be on the lookout for that next penny powerhouse – the next one might just be your best yet.
P.S. That’s a lot to look for. This kind of steady research and analysis can be very tedious. In fact, by the time you finish it, you may have already missed the boat. These penny stocks can shoot up in the blink of an eye. That’s why we send out the Penny Sleuth every business day. We don’t want readers to miss a thing. To get the insights we provide on the penny stock markets visit www.pennysleuth.com
Jonas Elmerraji is a contributor of the FREE daily e-letter The Penny Sleuth. The Penny Sleuth offers unbiased commentary from expert analysts and authors on Small Cap Stocks, Penny Stocks, OTCBB and Pink Sheet Companies.