April 2: Penny Stocks: Good Investment or Get-Rich-Quick Scheme

by David Jenyns on April 2, 2007

Penny stocks are defined as shares that trade at a price at or below $2.00. The Security and Exchange Commission (SEC) considers anything up to $5.00 as a penny stock, however this value is actually close to the price of many mainstream stocks. Many shares trade at only a few cents, however, this does not imply that the companies’ stocks are worthless. These stocks may be from relatively new companies or emerging fields.

If done right, trading in penny stocks can be an affordable option for those who want to get into the stock market. The profits from trading in penny stocks can become an income supplement rather quickly. For just a few hundred dollars, you can make thousands in returns if you jump on the right stock at the right time. In addition, many investors like the idea of being able to own a large amount of a good company’s shares for a relatively low cost. Trading penny stocks is also a great way to learn about the stock market without investing a large amount of money.

As with all investments, penny stock investments should be based on research of the market and companies’ financial history. Things to consider when looking at the companies financial history are the profitability of the company, whether they have announced losses and whether they have new patents or products. To find penny stocks, it is best to use a combined method such as buying penny stocks based on tips from professionals and using the services of a penny stock newsletter. Keep in mind that you also must do further research to decide if the penny stock purchase is right for you.

However, with the increased volatility of the penny stock market (as compared to more traditional stocks) comes an increased risk. Penny stocks are very susceptible to vast changes in price within a short space of time.

Many people enter the penny stocks market thinking that using penny stocks is an easy way to get rich. The chances that every penny stock you buy will raise to $5 or more a share are very slim, though. Many of them stay roughly around the original purchase price or, in the worst-case scenario, fade away to nothing.

This is a risk that many are willing to take. In order to minimize the risks of trading in penny stocks, there are a few steps that you can take. First, never follow penny stock tips that come to you for free. Many companies distribute tips through faxes, spam e-mail or phone calls. These unsolicited advertisements are part of a scam to start a rumor mill and force the price of a company’s stock up unnaturally. In most cases, the company is paying people to promote their stock.

Generally, the more you pay for a penny stock newsletter, the more valid the tips are there within. The best penny stock newsletter services are able to charge more because they have better quality leads and do more research on their leads.

Another way to minimize your risk in trading in penny stocks is to avoid stocks with low visibility. If a company does not send out regular financial reports, avoid investing with them. Only trade with penny stocks that are listed on the main exchanges, like NASDAQ and AMEX. Penny stocks with low tradability should also be avoided. If there are just a few shares being traded daily, then there is little investor interest. Focus your penny stock trading on higher volume stocks, and never invest in a stock that is not trading at least 20,000 shares a day.

Relying on reputable newsletters and professional opinions can help you avoid the hype created by many penny stock companies. Companies sometimes exaggerate their situation in order to get more stocks sold. Doing the necessary research and checking your sources carefully can minimize the risk of being victimized by hype.

To trade penny stocks all you need to do is contact a broker and open a brokerage account. The broker will take a small fee for each transaction that they perform for you. The broker will also walk you through the simple process of getting started.

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