Institutional investors like banks, hedge funds, and mutual funds generally avoid investing in penny stocks. This is mainly because very little information about penny stocks is available and the little that is is hard to trust. The Penny stock market is dominated by scammers luring potential investors with misinformation and hype.
This, however, does not mean that they do not offer the opportunity to make huge returns. Investing in penny stocks can be very rewarding if you do it right and avoid the hurdles that come with the trade.
What are penny stocks?
Penny stocks are shares of the small companies on Wall Street. They trade at meager prices, usually less than $5; they trade via the OTC Bulletin Board, Market Group or over the counter. A real penny stock trades at $1 per share. Investors use online stock brokers to buy and sell penny stocks.
The low price of penny stocks allows investors to buy them in large numbers. With a large number of shares, nominal price gains or losses translate into large percentage increases or losses. A few cents in nominal price gain can mean enormous returns for an investor and vice versa.
The risks of investing in penny stocks
The volatility of penny stocks makes them very risky investments. Prices swing even when a small block of the shares is traded. Before investing in stock, in-depth research is mandatory. Public information on penny stocks is very scarce. Various sites list hot penny stocks but not all of them are credible. Credible resource websites for penny stocks like Investors Hangout are rare.
Mitigating the risks
Most penny stocks trade in low volumes and have low liquidity. To minimize risk, avoid such penny stocks and only invest in those with high volumes and relatively high liquidity. A 90-day volume, for example, will make it easier to enter and exit a position. Look for penny stocks trading at least 100,000 shares a day with each share priced at more than 50 cents.
When investing in a penny stock, you need to find profitable companies whose earnings growth is robust. This can be difficult to find especially if you don’t know where to look. If they do not bombard you with misinformation, some companies will straight-up lie to get you to buy their stock. Be wary of who you trust and always perform your due diligence. Seek guidance from credible stock message board websites but take all advice with a grain of salt until you can verify it.
Brokers taking flat fees are ideal for penny stock trading. This is because high commissions will quickly eat into the returns of the low-priced penny stocks. Make sure the broker you use is licensed and SEC-registered.
Stock trading cannot be done in isolation. Investors use external resources to find the most suitable stocks. The same is applicable in penny stock trading. Given their volatility, having the right information to help you buy or sell at the right time is the difference between profit and loss.