5 Tips for Investing in Penny Stocks

Penny stocks are public companies, at high risk. All penny stocks low price stocks. According to Forbes, these stocks trade for less than $5 in the US market. Most experts say that penny stocks are highly risky. Only speculative traders should try and invest in these stocks. Are you planning investing in penny stocks? Then, here are 5 relevant tips for investing in penny stocks in 2024-25.

Learning More About Penny Stocks

You should learn about investing in penny stocks in depth, before you start investing. Experts say that most penny stocks are an illusion. You hope to double or triple your money through penny stocks. But inexperienced traders can fail miserably.  

In the US stock market, penny stocks are classified as SEC.  

But which companies issue penny stocks? 

The companies with dispute that cannot list their shares on major stock markets, use this window.  

However, you may find rare issuing companies on NASDAQ or NYSE too.  

Commonly, traders buy and sell these stocks through OTC transactions (over the top). Some follow the OTC Bulletin board for trading in penny stocks too.  

Going by their nature, the penny stocks are highly volatile. The price swings in these stocks are unfathomable. There are equally large frauds in penny stocks too.  

Major Risks of Investing 

Firstly, you will frequently find that reliable stock chart data is missing. Normally, the penny stock companies do not need to disclose their data transparently, as other companies must do.  

Many new companies also list penny stocks. There is negligible past data on these companies.  

Penny stocks can also indulge in illegal schemes like “pump and dump”.  

Want to know more about this practice? 

Mostly unscrupulous traders engage in this practice. They buy the stocks at large scale deliberately. Then they promote the growth features of the stock. After that the stock price increases.  

In the end, they sell their stocks at an artificially inflated value. Big companies have large media exposure. They have their own analysts too. But the small trading companies do not have such amenities.  

Hence, they cannot detect these unscrupulous schemers and lose big time.

Investing in penny stocks provides traders with the opportunity to dramatically increase their profits, however, it also provides an equal opportunity to lose your trading capital quickly. These 5 tips will help you lower the risk of one of the riskiest investment vehicles.

Here are 5 Tips for Investing in Penny Stocks:

1. Penny Stocks are a Penny for a Reason:

While we all dream about investing in the next Microsoft or the next Home Depot, the truth is, the odds of you finding that once in a decade success story are slim. These companies are either starting out and purchased a shell company because it was cheaper than an IPO, or they simply do not have a business plan compelling enough to justify investment banker’s money for an IPO. This doesn’t make them a bad investment, but it should make you be realistic about the kind of company that you are investing in.

2. Trading Volumes:

Look for a consistently high volume of shares being traded. Looking at the average volume can be misleading. If ABC trades 1 million shares today and doesn’t trade for the rest of the week, the daily average will appear to be 200 000 shares. In order to get in and out at an acceptable rate of return, you need consistent volume. Also, look at the number of trades per day. Is it 1 insider selling or buying? Liquidity should be the first thing to look at. If there is no volume, you will end up holding “dead money”, where the only way of selling shares is to dump at the bid, which will put more selling pressure, resulting in an even lower sell price.

3. Does the Company Know How to Make a Profit?

While it’s not unusual to see a start-up company run at a loss, it’s important to look at why they are losing money. Is it manageable? Will they have to seek further financing (resulting in dilution of your shares) or will they have to seek a joint partnership that favors the other company?

If your company knows how to make a profit, the company can use that money to grow their business, which increases shareholder value. You have to do some research to find these companies, but when you do, you lower the risk of a loss of your capital and increase the odds of a much higher return.

4. Have an Entry and Exit Plan – and Stick to It:

Penny stocks are volatile. They will quickly move up and move down just as quickly. Remember, if you buy a stock at $0.10 and sell it at $0.12, that represents a 20% return on your investment. A 2 cent decline leaves you with a 20% loss. Many stocks trade in this range on a daily basis. If your investment capital is $10 000, a 20% loss is a $2000 loss. Do this 5 times and you’re out of money. Keep your stops close. If you get stopped out, move on to the next opportunity. The market is telling you something, and whether you want to admit it or not, its usually best to listen.

If your plan was to sell at $0.12 and it jumps to $0.13, either take the 30% gain or better still, place your stop at $0.12. Lock in your profits while not capping the upside potential.

5. How Did You Find Out About the Stock?

Most people find out about penny stocks through a mailing list. There are many excellent penny stock newsletters, however, there are just as many who are pumping and dumping. They, along with insiders, will load up on shares, then begin to pump the company to unsuspecting newsletter subscribers. These subscribers buy while insiders are selling. Guess who wins here.

6. Checking registration with SEC 

You know that some of the penny stocks are available on the major markets also. You must check if it is registered with the SEC. You can trade an SEC registered stock from your brokerage account. 

But most penny stocks operate over the counter. They are entitled to no important reporting mandates. Hence it is impossible to project the growth trends of these shady companies.  
The bottom line is that it is best to avoid such companies. At best, you can invest in SEC registered penny stocks.  

Best Penny Stock Traders 

I suggest you get a brokerage account first. Or you may invest through a broker also. Most brokers do not charge you.  

Here I may suggest some trusted brokers.  

Fidelity

They charge zero fees. Their platform is easy to use also. They also allow you to access a versatile range of research tools.  

You can get volumes of company data through their tools. So, trust their process, if investing in penny stocks. 

Robinhood

They offered commission free trading in the US, for the first time.  

They don’t offer research tools directly. But you can get access to Level II NASDAQ data if you have a Robinhood Gold Subscription. 

Not all newsletters are bad. Having worked in the industry for the last 8 years, I have seen my share of unscrupulous companies and promoters. Some are paid in shares, sometimes in restricted shares (an agreement whereby the shares cannot be sold for a predetermined period of time), others in cash.

How to spot the good companies from the bad? Simply subscribe, and track the investments. Was there a legitimate opportunity to make money? Do they have a track record of providing subscribers with great opportunities? You’ll start to notice quickly if you have subscribed to a good newsletter or not.

One other tip I would offer to you is not to invest more than 20% of your overall portfolio in penny stocks. You are investing to make money and preserve capital to fight another battle. If you put too much of your capital at risk, you increase the odds of losing your capital. If that 20% grows, you’ll have more than enough money to make a healthy rate of return. Penny stocks are risky, to begin with, why put your money more at risk?

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