How to Buy Penny Stocks: The Complete Guide

Many investors want to know how to buy penny stocks because they offer the allure of huge profits in a short period of time.

They can bring triple- or even quadruple-digit gains in a matter of days or weeks.

how to buy penny stocksTake Plug Power Inc. (Nasdaq: PLUG), for instance. On Dec. 6, 2013, the stock was worth just $0.73 per share. After the first week in March 2014, the stock had climbed more than 1,025%.

That's a small jump compared to what some penny stocks gains have delivered. The right penny stock can bank the type of profits that let investors retire early.

Monster Beverage Corp. (Nasdaq: MNST) is the perfect example. In 1995, MNST shares were worth just $0.69 per share. They're worth more than $134 each today.

Investors who bought in when it was still a penny stock are looking at gains of 19,320%. An initial investment of just $10,000 would be worth more than $1.9 million today.

But, of course, not every penny stock is a winner. In fact, very few bring investors these types of returns.

Plus, the penny stock market is littered with scams. Many unwitting investors end up penniless victims after not performing the proper research.

In June 2014, shares of CYNK Technology Corp. (OTCMKTS: CYNK) soared 24,000% to $21.95. But the company was a scam, and the U.S. Securities and Exchange Commission halted trading in mid-July. When trading resumed, shares crashed to $0.20.

In order to help you find the winners and avoid the traps, we put together everything you need to know about how to buy penny stocks. These three tips will help you bank gains, while avoiding scams...

How to Buy Penny Stocks, Tip No. 1: Do the Proper Research

When researching penny stocks, you need to know where to look.

The first stop is where the company's stock is listed. Check out the NYSE, Nasdaq, or OTC websites for stock information, research reports, and company profiles. Always check the company's own website as well.

Another good step is contacting the company directly and requesting any information available. Most will offer financial and product information to investors. If a company does not provide this information, there is probably a reason why. Be wary.

If the company is located outside of the United States, research the political, economic, and social situations of the country. Don't forget to review the business laws of the country. The company will often provide this information for investors.

Look for companies that are ready to bring major products or medications to market. That is often a major catalyst.

"Many penny stock companies, especially health-related biotechs or innovative technology companies, spend years researching and developing their products," Money Morning Defense & Tech Specialist Michael A. Robinson said. "This may include lengthy and rigorous testing. Pharmaceutical biotech products can spend years in trials and tests."

Buyout candidates also offer a great penny stock opportunity, according to Robinson.

Finding a company that's prime for purchase could bring big gains to investors in a short period of time. Robinson suggests following M&A trends to see which industries are the hottest for takeovers.

Continue reading for two more tips on how to buy penny stocks...

How to Buy Penny Stocks, Tip No. 2: Stick to Major Indices

Many penny stocks trade on the Over-the-Counter Bulletin Board (OTCBB) or the Pink Sheets, rather than major indexes like the New York Stock Exchange or the Nasdaq.

How to Buy Penny Stocks

These are the three biggest guidelines for finding the best penny stocks and avoiding the scams:
No. 1 - Research Thoroughly: Check the index's website, the company's website, and contact the company directly. Make sure you're buying into a strong business, not a shell company.
No. 2 - Stick to Major Indexes: When possible, pick stocks that trade on the NYSE or Nasdaq instead of the OTC market or Pink Sheets. They are held to higher standards.
No. 3 - Don't Overspend: Only allocate a small portion of your portfolio to penny stocks. It's not a smart investing strategy to always bet on the long shot.

Some investors like the allure of finding obscure stocks on the Pink Sheets that few investors have heard of.

But there is a huge downside to these stocks. The OTC markets and Pink Sheets do not require the same reporting standards for financial information as the NYSE or Nasdaq. Scam companies can more easily pass themselves off as legitimate on the Pink Sheets or OTC.

If you want to venture to the Pink Sheets, use their classification system. The Pink Sheets put stocks in the "PremierOX" and "PrimeOX" categories.

PremierOX companies sell for at least $1 per share, have at least 100 shareholders with a minimum of 100 shares each, and meet the requirements of the major exchanges. PrimeOX companies have no minimum share price, but have at least 50 shareholders with 100 shares minimum.

Sticking to those two categories will help weed out scams and shell companies.

How to Buy Penny Stocks, Tip No. 3: Invest the Right Amount

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It's imperative to maintain perspective when buying penny stocks. Only allocate a small portion of your portfolio to the good penny stocks you've identified.

Betting on too many long shots is not a winning plan. Betting on the 50-1 horse every time may occasionally result in a winner, but it's a foolhardy strategy.

In other words, don't view penny stocks as your lottery ticket. Evaluate your penny stock investments like you would any other stock.

Never allocate more than 2% of your investing capital in a penny stock or other speculative investment. This way you will open yourself to huge profits while also protecting your money.

The Bottom Line: When done right, penny stock investing can bring huge gains in a short period of time. But the penny stock market can be dangerous for unwitting investors. Make sure to do the proper research, stick to the major indices, and not spend too much on one penny stock. Those are the three biggest keys when learning how to buy penny stocks.

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