Penny Stocks

We've all heard of the investor bragging about his 100% or 1000% return on a stock, or the person who got rich investing in small-cap, undiscovered stocks that made it big. In theory, it seems too easy. Invest in a few penny stocks and then sell them when they move up. Unfortunately, it's too easy. Too easy to lose money if you don't know what to look for.

First, let's see what types of companies trade on the OTC BB or Pink Sheets.

Stocks that no longer trade above $1 on the Nasdaq

These include companies that have fallen from grace (Enron). While they may see better days in the future, the odds are stacked against them. It is usually best to avoid trading these stocks. If you feel the temptation is too great, wait until the stock starts to rebound.

Every year there are hundreds if not thousands of companies that decide to go public. Whether they need money to expand their business or want to cash in on their equity, this is a natural progression for a company with a compelling story and a great IPO track record. While many of these companies will file for IPOs, many others will begin trading on the OTC BB as penny stocks.

Second, let's look at some tips to help the stock trader avoid costly mistakes.

Stocks listed on pink sheets are not required to file annual or quarterly reports. This makes it difficult to start your due diligence. Often the information is sketchy at best and usually biased. You should expect the shareholder to say good things about the company. If the company didn't have the potential, they wouldn't keep him. Or they may be hoping to unload their stock and hope to talk you into buying.

Stocks listed on the OTC BB file annual and quarterly statements. This provides a measure of financial success. You will find that most penny stocks lose money, either due to management incompetence or research and development. The key is to identify companies whose management can consistently make money, or at least meet their business plan and reduce costs.

Here's what I can tell you: be careful! See the disclaimer for the amount the newsletter pays to transfer the profile. Are they paid in cash or shares? You will likely find a correlation between the number of shares that are paid out and the rating on the hype indicator. Does this mean you should avoid any stocks where the company pays IR professionals in stock? No. Just keep in mind that they are selling the story, and if they sell the story to other shareholders, they gain. This isn't a problem if you get in early, but it can be a problem if you can't jump in right away.

Check out the reporter's record. Did they profile the winners? Are they presenting facts or are they presenting hype? Do they also offer free stock profiles? If so, you'll likely find that they do their research on all companies and try to make sure they're not selling you weak stock just to pay the bills.

If a company is paying IR professionals money to profile stocks to their subscribers, should you avoid it? Of course not. Treat payment as advertising. They promote the company and try to gain visibility. Like any company, the only way to gain awareness is through some method of advertising. So don't dismiss the paid profile as the hype. Keep that in the back of your mind when you read the profile, but pay attention to the profile. You might find a diamond in the rough that no one has discovered.

If you want to make money, you need to be able to buy and sell enough stocks to secure your profit or protect your capital. If ABC's daily volume is only 500 shares a day, it may take you several days to get a position worth taking. If bad news comes out, who will buy your stock? If the volume is low, stay away. It is not worth it. If you feel so strongly about owning the company, consider contacting the company directly to negotiate a deal.

If you buy into the hype, chances are you'll end up being the last person to own the stock while everyone else has sold their position. Look at the company, see what their business plan was and confirm if they followed that plan. Were they successful? Did they bring the product to market on time? Has the company followed through on its acquisition strategy as it set out? This hype can get you a quick jump, but if you're not watching your trading screen every second of the trading day, you're missing out.

There are thousands and thousands of penny stocks. Your position size should not be more than 2000-3000 USD. While this may not seem like much, keep in mind that it is not uncommon for a $0.10 company to drop to $0.05. That's a 50% loss. If your position is $10,000, a 50% deduction will only leave you with $5,000. Keep your losses to a minimum. If the company has done well and you are at the top, either take your profits off the table or add to your position and remember to reset your stop loss to protect your previous profits.

Make a plan before you shop. What are your reasons for buying? What is your exit strategy? Where is your stop loss? What is the point at which you want to take profit? Write down these answers before placing your order.

Penny stock investments can be profitable. Remember that you are taking on more risk than if you were to buy shares in a bank. That risk can be rewarded with returns you don't get with bank stocks, or met with a big loss and a bad taste in the mouth investing in penny stocks.