By Diane Alter, Contributing Writer, Money Morning•
With double- and triple-digit gains possible in just one day, it pays to know how to invest in penny stocks.
Just look at Luna Innovations Inc. (Nasdaq: LUNA). Today (Wednesday) the stock jumped 89.39% to $2.50.
And some of the top penny stocks profiled in Money Morning last year gave investors gains of 440%, 231%, and 214%.
Investing in penny stocks isn't for everyone, as they operate differently than the typical stock.
Known for wide price spreads, light volume, and reduced reporting standards, penny stocks are typically traded on the over-the-counter market instead of major exchanges such as the New York Stock Exchange. For these reasons, penny stocks are deemed speculative investments.
The U.S. Securities and Exchange Commission warns "investors in penny stocks should be prepared for the possibility that they may lose their whole investment."
However, there are plenty of legitimate and lucrative penny stocks, if you know how to invest. The key is finding the promising ones and steering clear of the rest.
How to Invest in Penny Stocks: A Primer
Before investing in penny stocks, first and foremost, it's imperative to understand the risks. Then, a little bit of groundwork can pay off by helping you avoid big pitfalls.
Here are the first six must-take steps for how to invest in penny stocks:
Verify the Source: Mailboxes and inboxes are frequently flooded with a flurry of penny stock investment opportunities. Researching both the touted company as well as who is doing the promoting can save you a bundle. Thanks to the worldwide web, it's easy to verify flaunted claims and determine if a stock has potential.
Find the Financials: Like scores of growth companies, many penny stocks have never turned a profit. But more important than profit when mulling a penny stock investment is the quality and frequency of financial statements. Look at the auditing firm, published dates, and health of the company and read all the asterisks. If you uncover any red flags, don't invest.
Use a Responsible Brokerage Firm: To invest in any stock, you must have an established trading account. Online brokerage accounts are offered from big and boutique Wall Street firms alike. Use a brokerage account that includes access to current and pertinent data such as charts, historical pricing, and headline news. And make sure fees and commissions won't eat away at potential profits. For your protection, and their own, most big firms require investors to sign a waiver that states the risks involved in penny stock trading are understood.
Higher Volume Is Better: Avoid stocks with daily volume less than 100,000 shares. "Penny stock may trade infrequently, which means it may be difficult to sell penny stocks once you won them. Because it may be difficult to find quotations for certain penny stocks, they may be impossible to accurately price," explains the SEC.
Take Your Gains: Have a strategy when investing in penny stocks. Use limit prices on buy and sell transactions, and use stop orders to limit losses. Plus, don't get greedy. Take profits when you have them. Even if you expect more upside, at least take out what you've put in and let the rest ride.
Don't Bet the House: Once you know how to invest in penny stocks and make some bets, do not invest more than you can afford or are willing to lose. Be prudent with all penny stock investments.