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Are you thinking about investing in the top penny stocks to buy? The first question investors interested in penny stocks need to ask themselves is whether penny stock investing (buying shares trading for $5.00 or less) is right for them.
Penny stocks are speculative investments and need to be viewed as such. Penny stocks can return excellent gains, but they can also plummet.
Case in point: aTyr Pharma Inc. (Nasdaq: LIFE). In the middle of April, LIFE shares rose more than 30% in one week, buoyed by news that its directors were heavily buying the stock (often an indication of confidence by those that know a company best) and the initiation of a rating by an investment firm.
The soaring share price placed LIFE on Money Morning's weekly list of penny stock gainers. (These are not stocks that Money Morning recommends, but a report of stock market movements over a week.) ATyr Pharma, which researches and develops treatments for severe and rare diseases, is engaged in phase 2 clinical trials for Resolaris, a treatment for facioscapulohumeral muscular dystrophy (FSHD), a rare genetic myopathy. LIFE shares closed the week of their run-up at $4.10.
Yet in early May, LIFE stock is back down to $3.26, a drop of nearly 20% from the April figure.
Here's what this story means to you as a penny stock investor…
When Looking for Top Penny Stocks to Buy, Assess Your Risk Tolerance
So, do you need nerves of steel to invest in penny stocks? Sometimes. Investors interested in any asset class need to take some time to assess their risk tolerance.
There are a number of questionnaires designed to help you investigate your beliefs and behaviors about risk and reward. Most ask multiple choice questions about hypothetical investment scenarios and other aspects of risk and your response to it.
This one, for example, asks what an investor would choose in certain scenarios. Would they rather have a sure gain of less than a maximum possible gain as long as the gain is a sure thing? Would they go for a maximum gain even if it means a high potential of losing?
One example asks what investors would choose if they were given $1,000 in addition to whatever they now own. The possible answers are "a sure gain of $500" or "a 50% chance to gain $1,000 and a 50% chance to gain nothing." Other questions ask you to choose how your friends would describe you, with answers ranging from ultra-cautious to a risk-taker.
Other questionnaires, like this one, ask specific questions about how you currently allocate your capital and how important certain goals (maximizing return, preserving capital) are to you.
There are, of course, no right or wrong answers. All risk-assessment questionnaires contain scoring advice and a final assessment of where on the risk spectrum you fall.
Other Questions to Ask Before Buying Penny Stocks
In addition to finding your risk tolerance based on behavioral questions, investors need to look at other aspects of their lives that can affect their risk tolerance.
Because of the stocks' speculative nature and volatility, penny stock investing comes with potential loss, just as all stock market investing does. How investors feel about this can be powerfully affected by the time horizon they are considering. A 35-year-old investor, for example, may be looking for top penny stocks to buy because of their potential for strong upside, thinking that there is plenty of time to earn back any loss. A 55-year-old investor may decide that, at a decade out from retirement, it is time to concentrate on capital preservation.
Income and Portfolio Size
The other factors that affect risk tolerance, of course, are one's income and portfolio size. If your income is sufficient to absorb some losses as well as benefit from potential gain, you may be much more inclined to look for the top penny stocks to buy. Similarly, the size of your portfolio needs to factor in to whether you are comfortable investing in asset classes with a potential for loss as well as gains.
Budgeting Your Asset Allocations
One method of investing in penny stocks is to budget asset allocations concerning them so they do not significantly affect portfolio size. Money Morning recommends that investors not place more than 2% of their overall portfolios in any one top penny stock to buy. Additional advice suggests that penny stocks only constitute a small percentage of any portfolio.
Ways to Evaluate Top Penny Stocks to Buy
If you've assessed your risk tolerance and find you do want to cautiously approach top penny stocks to buy, there are ways to approach them to maximize the potential of gains. (And if your risk-reward assessment indicated you were not a good candidate for penny stock investing, there are plenty of other asset classes!)
Look for Penny Stocks with Dividends
In some ways, penny stocks are no different from other stocks. Investors concerned about stock price fluctuations, or wanting to cushion themselves overall in a down-trending market, often look for dividend-paying stocks. Finding a penny stock with a dividend can be one method of protection from the volatility of penny stocks.
Avon (NYSE: AVP), for example, currently sells for $4.47 and has a dividend of more than 5%.
Avon's returns so far in 2016 made it No. 6 on Money Morning's "Penny Stock Winners in 2016," although again, investors should note that this is a list of which penny stocks have done well, not a specific recommendation.
Look for Unstoppable Trends and Potential Buyout Candidates
Top penny stocks to buy are often engaged in the research and development of innovative products. Indeed, one of the reasons they may be penny stocks is that these products have not yet come to market to be sold, and thus do not yet generate revenue.
However, companies that have successful products in growth sectors have strong potential upside. Money Morning Chief Investment Strategist Keith Fitz-Gerald believes that medicine is one of six "Unstoppable Trends" that are poised to expand their related market sectors. Medical spending will be expanding in the United States and globally.
Biotechnology companies such as Novavax Inc. (Nasdaq: NVAX), a biotech company that is researching vaccines for pandemic flu viruses and rabies, is positioned to benefit from growth in the medical sector. In addition, its Recombinant Nanoparticle Technology has the potential to manufacture the vaccines in a much shorter time frame than other methods.
Money Morning Small-Cap Investing Specialist Sid Riggs believes that Novavax's methods and products could make the stock climb significantly upward. It was one of Money Morning's 3 top penny stocks for April. Barron's also believes the stock will climb in 2016.
Research Diligently for Top Penny Stocks to Buy
Anyone looking to invest in top penny stocks to buy should research the stocks they're considering diligently. Look carefully at the financials, the plans, and the products. If you can't find research, don't be afraid to walk away entirely.
It is also a good idea to invest in stocks listed on the New York Stock Exchange and the Nasdaq. These exchanges have stricter reporting requirements than the Pink Sheets or the Over-the-Counter Bulletin Board, where penny stocks are also often listed.
If you are researching penny stocks, download our free report: This Penny Stock Will Double Your Money — and Save a Dying U.S. Industry.