Here's what you need to know to get started...
Some financial advisors consider penny stock investing akin to gambling for three reasons:
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...
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...
If you don't already have one, choose a brokerage account. Consider these points when opening a brokerage account for penny stock trading:
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...
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.
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.
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