How to Buy Penny Stocks

how to buy penny stocksBefore diving into the nuts and bolts of how to buy penny stocks, it's important to recognize the reason why so many people engage in this particular type of investing. Penny stocks represent an inherently riskier, though potentially lucrative, investment option for investors.

Here's what you need to know to get started...

How to Buy Penny Stocks: Recognize The Risks

Some financial advisors consider penny stock investing akin to gambling for three reasons:

  1. Many penny stocks aren't openly traded on the stock exchange. This means that they aren't subject to the same degree of scrutiny and vetting that traditional stocks are subject to.
  2. Liquidity, or more specifically, a lack thereof, is another problem. It's not always a simple matter to find buyers for penny stocks, at least not at a profitable price. That leaves investors "holding the bag" or lowering their prices to the point that the stock is no longer profitable for them.
  3. Because they have a lower prices and trading volume than other stocks, penny stocks are vulnerable to manipulation by those who have less than honorable intentions.

With these risks in mind, be aware that not all penny stocks are created equally - some can be solid investments with wonderful upside potential. Additionally, there are ways investors can minimize their risk.

It all starts with research...

How to Buy Penny Stocks: Do Your Homework

Before you invest in penny stocks, take time to explore the business side of the companies behind the stocks. Learn about a company's products, outlook, and reputation. Information is your best tool for finding the true gems among the bulk of penny stocks.

Additionally, look for signs of "pump and dump" type tactics, where speculators drive up the prices by buying a large volume of a specific stock and then initiating massive sell-offs when other people begin to notice and start buying. The strategy is sometimes accompanied by an email or cold-call frenzy promoting a particular stock and promising phenomenal return on investment (ROI) to buyers who get in early. Plus, the lower the trading volume, the price, and the market cap, the more susceptible the stock is to manipulation.

Once you've landed on a promising, solid penny stock to buy, the next step is setting up the means by which to trade...

How to Buy Penny Stocks: Open a Brokerage Account

If you don't already have one, choose a brokerage account. Consider these points when opening a brokerage account for penny stock trading:

  • Account minimum
  • Costs per trade
  • Degree of information provided (charts, historic stock prices, etc.)
  • Annual fees
  • Trading restrictions
  • Terms and conditions
  • Minimum purchase sizes
  • Special fees

Make sure to compare the total actual costs of the account, rather than the simple transactional fees and costs, when making a selection.

Next - and perhaps most importantly - implement a trading strategy that minimizes risks and maximizes gains...

How to Buy Penny Stocks: Develop a Trading Strategy

It's important that investors create strategies that take into account important details, such as investment goals, risk aversion, stage in retirement preparation (younger investors have more latitude for risky transactions than those rapidly approaching retirement age), and level of financial security outside of penny stock trading.

Using stop/limit orders and proper position sizing relative to average volume can both help minimize risk when trading penny stocks.

How to Buy Penny Stocks: Making the Trade

Also referred to as executing a buy, don't go for broke with a first-time transaction. Use this as an opportunity to test the waters and get comfortable with the trading experience. Don't forget to keep accurate records, from start to finish, so Uncle Sam gets his fair share at tax time.

Always keep in mind that investing in stocks, penny or otherwise, is not a lifetime commitment. When the relationship is no longer giving the return you seek, it's time to sell and move on. Some are great for short trades, while others may serve nicely as long-term investments.

Investors who have wiggle room in investment portfolios, who are just beginning to save for retirement, or who enjoy a gamble can do quite well with penny stock investing. A well-rounded investment portfolio, though, does not sink all retirement hopes on one type of stock. Penny stocks should represent a small portion of any investment strategy, and not the full scope of your portfolio.

NEXT: We've identified three of the best penny stocks to watch in 2014 - and they're already up 1,097.76%, 54.06%, and 97.87% in the last 12 months...

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