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Penny-stock traders are like the Rodney Dangerfield's of the investment world – they get no respect from their bigger brethren.
But that doesn't mean they should be ignored.
Fact is, while penny stock investing can be risky, it can also be extremely lucrative. Some of the most successful investors in the world became rich buying stocks for pennies on the dollar and selling for $10 or $20 a share.
The key to success is to fully understand all those risks…avoid them at all costs… and then make the right moves so you can safely realize the big profits.
Let me explain…
Penny Stock Basics
So-called "pennies" get their name from their low price. They typically trade for less than $5 a share. (And many trade for true pennies, with share prices well under a dollar.)
The SEC generally defines them as securities from small companies, most of which trade on the Over-The-Counter-Bulletin Board (OTCBB) and Pink Sheets, LLC. Both have minimal listing requirements.
The fact that penny stocks aren't regulated (especially on the Pink Sheets) can be nerve-racking to some.
But it's overly cautious to think of penny stock trading as the Wild Wild West of the financial world.
Keep in mind that fraudulent misrepresentation of financials is a Federal offence no matter where a company's shares are listed.
Nevertheless, penny stocks have much fewer shareholders than a typical SEC-regulated stock.
The good news for you is that this lack of liquidity makes it much easier for the share price to spike with a major shift in trading.
For example, a gain of just six cents for a 30-cent stock means a 20% jump in valuation, whereas a 6-cent gain for any stock trading on the New York Stock Exchange wouldn't turn many heads.
Bottom line: While penny stocks are very volatile in the near term… (they can plunge just as fast and they can skyrocket)… it's the very same volatility that gives them such a hellacious upside -and makes them one of the best wealth-creating categories of stocks you'll find anywhere.
How To Tell The Genuine Article From The Imposters
Penny stocks are plentiful – about 6,000 of them are available today. Trying to sort through all of them can be daunting. That's why I created three "buckets" to help organize and categorize them.
Bucket 1: "Penny Diamonds" Micro-Cap Gems With High Growth Potential
If you're looking for a tiny, virtually unheard of company with a new technology, product, service or drug that's poised for a big breakthrough, the OTCBB or the Pink Sheets is the place to start.
As I mentioned, companies that are involved in this kind of over-the-counter trading fall just outside of the many regulations that restrict the activities of the major stock exchanges.
That means they don't adhere to many of the time-consuming accounting and finance regulations of the SEC.
But to make traders more comfortable, Pink Sheets LLC recently created a new classification system to help investors assess the legitimacy of the companies in their roster.
The highest is called "PremierOX." Companies under this classification must sell for at least $1 a share, have at least 100 shareholders with a minimum of 100 shares each… AND meet the requirements of all the major exchanges.
The second level is called PrimeOX. There is no minimum share price here but companies must have at least 50 shareholders with a minimum of 100 shares to gain entry.
There are other classifications – including the legitimate OTCQX for international companies. The complete hierarchy can be found at the Pink Sheets Web site.
But generally speaking when looking for those "Penny Diamonds" you should stick to the top two tiers.
Of course, finding the "next big thing" is not going to be easy. It won't just pop out and announce itself to you. That's why research is imperative. Do your homework. Here are some rules of thumb:
- Always review the company profile on Pink Sheets and the company's own website.
- Always request information directly from the company you're interested in. Whether by phone or e-mail, get in touch with a representative of the business and request any information they can send you – whether it is about their finances, their products or, if overseas – the political, economic and social situations in their countries. Risk assessments and future opportunities – anything you need to know to be sure of a company's potential – are also important.
- Do not even consider a company that isn't forthcoming with their information. Be wary of companies that will not consider treating the interests of their minority shareholders as their own.
- If the company you're researching is outside the U.S., you should also research the business laws inside the company's home country.
Once your homework is done, it's time to look for a catalyst. A catalyst can be any type of event, date, or unique situation that could create a spark that'll send your share price soaring.
Here are two big catalysts to look for:
Ready For Market:
Many penny stock companies (particularly health related biotech's or innovative technology companies) spend years researching and developing their products. This may include lengthy and rigorous testing. Pharmaceutical biotech products can spend years in trials and tests.
The catalyst occurs when the company is ready to go to market. Look for the end of trial dates… or actual roll-out dates. That means the company is ready to manufacture and sell its products and services. For biotech's, it also could mean a promising drug is nearing FDA approval.
Many small companies are prime buy-out candidates. Typically these companies have a market niche, a technology, a promising drug, product (even patents) that a larger competitor desires. When one company buys another, they agree on a price. Many times, that price is much higher than with the penny stock's company's price is currently trading. This gives those shareholders an instant gain.
My advice is to follow Merger & Acquisition (M&A) trends to see what sectors are hot.
For example, record-breaking M&A activity is occurring in the pharmaceutical biotech sector right now.
That's because big drug makers risk losing $170 billion in annual sales when patents expire on their most lucrative drugs. So they're battling back, embarking on a multi-billion-dollar shopping spree, buying up small players who can replenish their pipelines.
Imagine if you buy a sensational penny stock biotech for under a dollar and the company gets bought up by Big Pharma. It's practically guaranteed that you'll see sizeable gains.
Bucket 2: Fallen Angels
Not all penny stocks are unknown companies traded over the counter. There are also companies that already have their fair share of recognition… perhaps even trading on the major exchanges… but whose stock price is under $5.
Some of these companies I call Fallen Angel's. A Fallen Angel is a high quality company whose stock price has declined due to market forces out of their control. For example, a company may lose market share due to a business and economic cycles in their particular industry… a recession… or even a market crash. Some of these companies have very strong fundamentals, still trade on the major exchanges, and offer very substantial upside.
In short, a Fallen Angel gives you a tremendous value play, selling at significant discount to their intrinsic value and represent terrific bargains. At the end of this report, I'll tell you one of my current favorite Fallen Angels.
Bucket 3: Shell Companies
Pink sheets are often sprinkled with "shell" companies that exist on paper but have no assets. They simply exist for one purpose: To inflate their stock price and cash out. These are the penny stocks you need to avoid at all costs.
How do you recognize and avoid these types of stocks?
I provide details about penny stock traps and scams below… but keep this in mind:
Many of these companies resort to tactics such as high pressure telephone calls, email marketing schemes and phony promotion ploys that try to convince you their stock is about to go through the roof.
The truth is, most of these marketing schemes are run by professional promoters who make a good living spreading rumors about penny stocks.
Often these illegitimate companies could see their stock ramp up… then instantaneously drop 50, 60, even 100%.
Pump And Dump
The most common type of penny stock scheme is called the "Pump and Dump."
This scheme has been an investor pitfall to avoid the penny stock world for a long time. A classic "Pump and Dump," works like this:
A holder of a big block of penny stock shares orchestrates a "whisper campaign" to pump up a penny stock company and its product. Traders rush in, driving the price skyward, enabling the perpetrator to "dump" his shares at a big profit. Those left "holding the bag" lose big time.
Here are some signs to watch out for:
- Penny stocks that have "guaranteed performance." ( There's no such thing)
- Penny stocks that have extremely low volume. (It's impossible to tell where this stock is heading, making it even more risky than most)
- Penny stocks that you hear about from friends, at the office, over the phone or a social venues(These are typically stocks being pushed by talented marketers)
Tips On Investing In Penny Stocks Safely
You can avoid the common penny stock pitfalls pretty easily. Here are some safety tips.
First, remove the dollar signs in front of your eyes and replace them with company research. Start by looking for companies with financial track records, an important screen that eliminates 95% of the "shell" penny stock companies out there. Be a skeptic.
In other words, dig deep to make sure the company is sound and their business make sense.
Once you decide on a company, you should "know" that company inside out. Know what it does… how it does it… how it makes money… and especially its management.
Second, apportion only a small amount of your overall portfolio to penny-stock investing. That means that you can't clutter your mind with a lot of "what if" long-shots – such as, "what if this stock soars…I'd be able to buy a vacation home or retire rich by 49."
That kind of financial sobriety sounds boring, but sobriety today means there's no hangover tomorrow.
Once you have thoroughly researched your stock of choice and purchased it through your broker or online, be prepared to treat it as a long-term investment.
These stocks are smaller companies that are not constantly watched by analysts and regulators. They can sometimes go days without even a single share changing hands.
This will no doubt make some of the nail-biters out there anxious. But most intelligent investors find it liberating to be able to forego the short-term roller-coaster ride and focus on growth potential over the course of a company's natural life.
That doesn't mean ignore your investments altogether. Make sure you keep up with the information coming from the company and any third-party news stories – just like you would with an investment on a traditional exchange. But don't sell just because you don't see a change over a few hours or days.
Finally, don't get greedy. If you realize big gains on a stock at first, you could still end up losing money. You need to understand not only when to get in… but when to get out.
Here's A Great Penny To Get You Started…
Businesses worldwide lose a staggering $221 billion a year due to data theft. Americans are affected to the tune of $54 billion.
Little wonder that cyber-security has become a true growth market in the global-technology sector.
Global spending on network and data-security technology will rise from about $6 billion last year to more than $10 billion by 2016, according to a market-outlook report by technology-forecaster ABI Research.
Those numbers are big – but they may understate the actual outlays. Another study, this one by Forrester Research Inc. (Nasdaq: FORR), found that the share of business IT budgets devoted to security nearly doubled from the 7% recorded in 2007 to an estimated 14% last year.
So how do you profit?
One company with the greatest potential upside is the Lee, MA-base Wave Systems Corp. (Nasdaq: WAVX).
Wave develops, manufactures and markets digital-security products compatible with standards of the Trusted Computing Group (TCG), an industry organization that's made up of manufacturers and vendors of both hardware and software. Its products address such digital-safety issues as identity protection, digital signatures, secure financial transactions and network security.
Wave Systems has posted steadily rising revenue for the past five years – while narrowing its bottom-line losses. The company is now poised to turn the corner: The 2010 fiscal year loss of 5 cents a share is up from a loss of 43 cents in 2007, and Wave is expected to post a profit of 21 cents in 2012. Talk about making crime pay…