Trading penny stocks can be an exciting and lucrative way to learn about investing. However, It is also a high-risk play and can result in significant loss of money. Penny stocks are defined by the U.S. Securities and Exchange Commission (SEC) as "low-priced (below $5), speculative securities of very small companies." They are quoted over-the-counter, such as on the OTC Bulletin Board or in the Pink Sheets, and on some other exchanges. Although many companies that trade as penny stocks are legitimate companies that can prove to be good investments, there are also a large number of fraudulent or non-operating companies.
1. Open a cash account at a major online brokerage firm. Make use of their investor education facilities. Learn how to read company financial reports and how to trade stock using technical analysis of stock price charts.
2. Familiarize yourself with the information available on the OTC Markets and Financial Industry Regulatory Authority (FINRA) websites. FINRA regulates over-the-counter stocks. OTC Markets is a publicly trading company that provides electronic quoting and trading technology for the U.S. over-the-counter stock market, as does FINRA. These are important sources of information that will help you determine whether a company is legitimate and is reporting its financials and significant information.
3. Choose an industry you understand and use an interactive stock filter to identify microcap stocks in that industry. Microcap stocks are companies that have a market capitalization between $50 million and $300 million. These filters are available on the websites of most online brokerage firms and on the OTC Markets website.
4. Select companies that have a history of increasing revenues and earnings. Most stock filters will contain some financial information. For additional information, check for press releases and disclosure documents listed on the FINRA and OTC Markets websites. Avoid companies that show a recent negative reversal of fortunes. These may be good buys, but they might have further to fall.
5. Check the stock price charts for the companies still on your list for consideration. Select a company that has an attractive chart showing a possibility of an upside price break-out. Don't try to read the charts unless you have learned the basics of technical analysis.
6. Divide the funds you have set aside for investment into three equal parts. Invest the first third in the stock of your choice, and wait to see what happens. If the investment turns out badly, sell the stock and start all over with your selection and research. Then use the second third to invest in a new stock. If your first stock shows some regained promise, go back in with whatever is left of your first third. Try to reserve the final third of your money to use for adding to your positions, if they turn out to be worthy investments.
- The Pink Sheets section of OTC Markets has created a three-tiered system intended to assist investors in identifying legitimate companies. This system is defined by the Pink Sheets as "current information for companies that do submit regulatory filings and make them available. Limited information for companies with financial reporting problems or in financial distress or bankruptcy. No information for companies unable or unwilling to provide disclosure to regulators, exchanges or the Pink Sheets. It may include defunct companies or companies with questionable management and market practices."
- Be wary of investment tips from friends, relatives and email stock promoters' newsletters. By the time you receive these tips, the action in the stock might have already taken place, and you could be buying in at a high price. Also, some stock promoters are being paid to attract investors to a stock, and as the stock price rises, they often dump shares on the market, driving the stock price down. This is what is known as "pump and dump," and it's illegal.
- Comstock/Comstock/Getty Images