Due to the large apparent opportunity for profit, new investors are sometimes attracted to penny stocks.
The small buying price often entices traders to buy in, hoping that with just a share price raise of a few pennies their money can double.
Typically, however, penny stocks are more volatile and less predictable than the shares of well-established, large companies.
Unlike the stocks of larger companies, penny stocks are more often involved in schemes to take advantage of buyers who want to get rich quick. However, if you can do your due diligence in researching and understanding the odds, penny stock trading can be a lucrative ordeal. There are many factors, however, which can ultimately lead to your success or failure in churning a profit in the volatile penny stock market.
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Here are three strategies to help you make the best decision when trading penny stocks.
1. Read the Disclaimers, Not the Tips
Believe it or not, penny stocks are more often sold than they are purchased. One of the primary motivating factors that encourages people to buy penny stocks are the marketing emails and newsletter you can find online and in social media. These tips are misguiding in the sense that they are meant to provide a benefit to the party who is issuing the advertisement – not to the buyer.
In other words, the interest of the penny stock sellers is not for you to get rich, it is for them to get rich off of your investments. Because of regulations implemented by FINRA and the SEC, most news blasts of this sort are now required to include disclaimers at the bottom. If you read the disclaimer, you will see that they are getting paid to sell a stock for their investors and for exposure. Thus, the promises of getting rich are made only with the plans of self-interest.
2. Don’t Listen to Company Management, and Watch Out for “Pump-and-Dump”
When you are analyzing factors and making decisions on which penny stocks to sell and buy, keep in mind which of your sources are viable and which are biased. When you receive information from the company who is issuing the stock, be very weary. The goal of the company is to encourage people to buy into and raise the price of their share.
Thus, the information they provide is meant to you guide your hand into purchasing additional shares of their stock. For the company, a raise in share price can open the door for opportunities to raise funding and keep their business going. Without any sound data or reliable business model, many penny stocks are merely tied with companies trying to inflate their value as a means of driving profit.
Also, be weary of “pump-and-dump” scheme. This occurs when a seller artificially inflates the value of a stock so that he can sell his shares at a higher value. First the seller will “pump” the stock by broadcasting an inflated value of the stock so that others will buy in at a higher price, and then he will “dump” the shares by selling them.
3. Do Company Discovery
Remember, when you buy a penny stock, you are buying more than just a stock on a piece of paper – you are buying a portion of the company. The entity that you should be concerned with, therefore, is the company itself. The performance and overall health of the company will be more indicative than any other factor.
By doing proper research on the company and stock, you can obtain an objective, fact-based understanding of where the stock price will reside in a few days or weeks. Remember to be cynical, and to separate objective facts (often distributed by third parties and other officials) from the information that the company is giving you. Find stocks that have demonstrable and substantial evidence for upwards growth; don’t just rely on your gut instinct.
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One of the main goals in penny stock investing is to make it as predictable as possible. While the prices will fluctuate – by doing sufficient company discovery and investigation before investing, you will have a better sense of predicting the outcomes than you would otherwise.