While investors and brokers typically consider penny stocks as high risk, they do provide a way for individuals to break into stock market trading with little investment, since you can buy a penny stock for less than $5 per share. Even stocks that generally rise in value can drop to penny stock prices in a recession, leaving the possibility for individuals to purchase blue-chip stocks for little investment per share. The U.S. Securities and Exchange Commission warns that penny stock investors may lose their investment.
1. Research penny stocks before investing using websites such as OTC Markets. While the SEC considers any stock trading below $5 as a penny stock, many investors consider penny stocks as any stock trading for less than $1. Still others consider any stock traded on the over-the-counter exchange or listed on a pink sheet -- the traditional color of the papers listing cheap stocks -- as penny stocks regardless of their price. Manuals published by financial institutions such as Standard and Poor's and Moody's contain the most recent corporate financial reports for most traded company stocks, including penny stocks. Reading these manuals, as well as SEC reports, can provide valuable insight into the potential for the price of a stock to rise or fall.
2. Practice trading penny stocks before you invest. Research various stocks on penny stock websites to select one or two that you believe are good investments. Determine the number of shares that you would buy if making a real purchase and track the stock's gains and losses to decide whether or not a purchase with real money is an acceptable risk.
3. Locate a broker with expertise in trading penny stocks, but be wary of those who say they specialize in penny stocks. Penny Stock Nation provides a listing of brokers that trade penny stocks with contact information and descriptions of each broker. Penny stocks are hard to predict because they behave differently from higher-priced stocks, so a knowledgeable penny stockbroker is essential to minimizing your loss potential. According to the Missouri Secretary or State, be wary of brokers who use high-pressure tactics to get you to purchase a certain penny stock, because their only goal may be the commission they make from the sale, not protecting their clients from worthless stock.
4. Talk with your broker to compare your practice trades with real-life conditions. Your broker can discuss with you the risks involved when you invest in penny stocks. Read the company's prospectus to learn how the company will use your investment and discover the history, management and capitalization of the company. The company should only capitalize long-term expenses such as property and equipment. If it is capitalizing its normal operating expenses, it may be covering up expenses to make it appear that it has more cash flow than it actually does.
5. Place an order by telling your broker how many shares you want to buy and how much you are willing to pay for them. Specify your order's duration. The broker will purchase shares when the price falls to your purchase price. Reinvest your profits by buying additional stock in profitable companies to diversify your portfolio.
- The amount of time that you track a stock before purchase is up to you. A cautious investor might track the stock for a month or two before making a real purchase. However, barring unforeseen market fluctuations, you might be able to make an informed decision within a few weeks.
- If you do not purchase your shares in bundles of 1,000, you might have to pay extra broker charges for each purchase.
- Trading in penny stocks is very risky. There is a large chance that you will lose your investment. Do not believe any broker who tells you that a penny stock has no chance, or even little chance, of losing value.
- Thinkstock Images/Comstock/Getty Images