Penny Stocks for Dummies Guide – A Quick Synopsis for the Neophyte Trader
I thought I’d sum up the basics of penny stocks in one simple post that anyone can read and immediately gain a good foundation of what they are and some of the better ways to find profitable penny stocks to buy. The fact that you are reading a penny stocks for dummies article makes you not a dummy. Information is how anyone succeeds, and penny stocks are no different. It’s a smart thing to have a good understanding of penny stock investing and performing adequate research before even thinking about buying penny stocks. Bear in mind that each of following categories can certainly (and should) be looked into with much greater detail but this should get you started.
What Are Penny Stocks?
A penny stock has many definitions. For those who only trade on the large stock exchanges a penny stock is any stock that is less than $5 per share. The other definitions are generally based on market value. The market value is the number of shares multiplied by the price per share. Penny stocks are usually stocks with a market value less than $200 million (this number can vary.) The most obvious definition is any stock with a price less than $1 per share. The last definition you may see is any stock that is traded OTC (over the counter) or on the pink sheets.
Regardless of your definition the point of penny stocks is your trading lower valued companies that have less information about them because the company isn’t required to have independently audited records and is never covered by a stock market analyst because virtually no one would read about it or pay for the information.
Penny Stock Risks
Without a doubt, the penny stock carries more risk than the average stock. The primary reason for this is the low value of the company makes the price easy to manipulate by wealthy individuals or small groups of people. A 100 billion dollar company can’t easily be manipulated by any individual person. A $50 million dollar company however can have 20% of the whole company traded by thousands of different individuals or small trading groups. Surges in buying and selling activity can manipulate the value of the company on the short term causing inexperienced traders and investors to change their buying and selling activities. This type of activity can be shady at best. Worse still, other people move beyond shady and into scams.
There are two primary penny stock scams that focus on the inexperienced traders and investors. For traders the biggest risk is the pump and dump. Here an advertising campaign will get a certain penny stock very hot by getting people who aren’t even into penny stocks, buying them. Then this will trigger your trading signals which under natural conditions would make a great trade. The scammers then dump all of their stock quickly into the buying spree. Once the marketing campaign is over and the scammers made their money, they are out and the price collapses.
Penny Stock Trading and Investing
In general when penny stock trading you’ll often do better with short term trading rather than holding stocks for years. This is because the longer your trade is the more risk you apply to your trade with scammers coming in or companies having negative information released. When penny stock investing you’ll also do best if your good at getting information no one else has. This is usually done by talking with people who work at these small companies to see how viable the company truly is. Those who are willing to go deeper than the information available on the internet can really win huge with penny stock investing.
Traditional technical analysis (i.e analyzing stock charts) and fundamental analysis (analyzing the financials) can also both help narrow down a profitable penny stock from a dud so don’t underestimate these traditional yet very effective stock screening methods.
Hopefully this provides a good “penny stocks for beginners” overview but don’t stop there; educate yourself further by reading my other posts and consider subscribing to a reputable penny stock newsletter. The more informed you are with proven penny stock strategies and solid investing advice, the better your outcome.
Follow a System that Works
Now if you’re really serious about making money trading penny stocks I highly suggest you subscribe to a reputable newsletter that provides real-time trading alerts and has a proven track record. Trading penny stocks is a high risk, high reward venture so it is absolutely vital to have a seasoned professional guide you.
One such newsletter I can recommend is called Microcap Millionaires run by Matt Morris and the main reason I like his service (aside from the nice gains) is his straight honesty – Unlike other newsletter and alert services out there that are often nothing more than paid penny stock pumpers, Matt is an actual trader who cuts through the bull and gives you his straight unbiased recommended trades.
But before I go any further I must say that though Matt’s real-time alerts can be extremely profitable, if you’re the type of person who has a hard time following instructions and instead lets your emotions drive your trades then please do NOT bother subscribing as you’d only be wasting your time and money. The reason I say this is because for you to really succeed with Matt’s service (or any trading methodology for that matter), you need to be highly disciplined in your trades. For example if you buy a recommended stock and it jumps up to the target price, sell your stock and lock in your profits. Don’t get greedy and hold the stock longer than suggested or you could very easily get burned. Also do not invest too much of your capital in any one stock – yes the majority of his trades are profitable, often very profitable, but you still need to spread the risk evenly so as to protect yourself from the odd potential loss.
Now just to forewarn you, when visiting his site the first thing you’ll probably notice is, well it’s a bit plain (sorry Matt ) but that’s just the type of guy Matt is. He’s not about making things look pretty, he’s about results and if you follow his stock alerts with discipline, you’ll likely be shocked by the type of consistent profits you can yield. Click here to learn more about Matt’s Microcap Millionaires newsletter.
Common Attributes of the Best Penny Stocks To Buy In Any Given Market
Finding good penny stocks is not easy to say the least. In fact there is no sure fire way to pick the right stocks at the right time all the time. If there were, we’d all be rich. ) The truth is choosing the top penny stocks to buy is more of a best guess rather than a solid formula.
Having said that however, don’t let this deter you as there are a number of indicators you can factor in when looking for hot penny stocks which can significantly increase your rate of picking profitable penny stocks versus losing ones. You should never just use one indicator when picking stocks however. All indicators should be looked at together as a whole to more accurately analyze a penny stock’s potential. The following are some indicators to consider when penny stock investing:
Strong Price Movement – If a stock has large percentage price gains with heavy transactional volume over the course of a number of days, this could be an indicator that the stock is starting to trend up and build momentum.
ROE (Return On Equity) – ROE, often considered the most important ratio in stock analysis is essentially the quantity of net income returned as a percentage of shareholders equity (SE). It’s calculated by dividing the net income by shareholders equity. Penny stocks with a positive ROE no matter how small indicates the company has value and is turning a profit. In other words it’s a sign of quality.
Technical Analysis Indicators – Technical Analysis is a way to predict a stock’s future performance based on past performance. One of the most important indicators is the MACD ( Moving Average Convergence / Divergence) ratio. The MACD ratio measures whether a stock is trending up or down. The idea is that if a stock is trending up it has a tendency to continue that trend until of course the trend starts to change (which the MACD can also indicate). The most common parameters used in the MACD ratio are (12,26,9). Another popular indicator are moving averages, particularly the 50 day and 200 day moving averages. It is believed that if the stock is above the 50 day, it’s a positive sign and if the 50 day is above the 200 day, even more so.
Sound Business Model – There’s all sorts of companies out there and most of them love tooting their own horn, often sending out press release after press release in an attempt to get attention from both the traders and investors. Now some of these stocks may sound very tempting to buy but if the business model behind the company doesn’t make sense to you, don’t buy their stock. Simple as that. There are so many good micro-cap stocks out there with huge potential so why trade something you either don’t understand or don’t believe in?
Insider Buying – When company insiders are buying their own company’s stock, it’s a very positive indicator. The reason is quite simple. They believe in their company and the future growth of the stock; why else would they be buying? And who knows the true financial condition of a company better than those running it? Enough said.
Actively Promoted – This is one is especially significant to day traders and short term traders. Essentially, if a stock with a small float (i.e. very few outstanding shares) is being actively promoted by various IR companies, penny stock newsletters, paid pumpers and the like, the stock is very likely to appreciate in value, at least during the promotion. A typical promotion can last a day, a few days, or even several months. Like the other indicators, this one shouldn’t be used in isolation when finding good penny stocks to trade and timing a stock promotion can be very risky. That being said, this one factor should not be underestimated as it can have a huge impact on a microcap.
These indicators will go a long way in helping you find the very best penny stocks with the highest growth potential. Here’s to your financial success.
Are Free Penny Stock Newsletters Scams?
If you’re even remotely interested in trading penny stocks chances are you’ve come across and perhaps even been tempted by all those free penny stock newsletter and alert services scattered across the Internet. Heck even I have subscribed to a few in the past, mostly out of curiosity – I mean they just sound so appealing; the ability to receive endless free penny stock alerts without having to perform your own research which, lets face it, can be a huge undertaking. But the reality is these free stock alerts are not what they appear to be. I’m not going to go as far as calling them scams but they are definitely not objectively chosen stock picks. How can I say this for sure? Read on.
The Penny Stock Promoter
How to Spot a Penny Stock Promoter
So you might be asking yourself how you can identify a penny stock promoter versus a legitimate penny stock advisor. Well, aside from the fact that a true penny stocks advisor would never freely give out his picks indefinitely, you can also fairly easily spot a penny stock pumper by reading the fine print! Seriously, if you look at any of these sites or the e-mails they send out, they must legally have a disclaimer stating that they were either compensated for their “stock picks” or that their picks should be considered advertisements and not actual stock picks!
What About One Time Fee Newsletters?
Aside form the “free” newsletters, you may also come across one time fee newsletters. Basically they offer you a lifetime of stock picks for just one initial fee. That may sound good to you and perhaps more believable but these “newsletters” are actually even more of sham than the free ones. Not only are they just giving you pumped stock picks, they actually got you to pay from them! Imagine paying money for someone to advertise to you instead of providing actual well-researched stock picks?!
My Recommended Penny Stock Newsletters (Hint: they’re not free!)
So after all this you’re probably wondering whether there are legitimate newsletters out there that actually provide real and profitable stock picks? The answer is yes and guess what? All of them are not free! Instead, they are typically based on a paid monthly subscription. Now you may not like the idea of having to pay each month for a service but when you think about it, in this situation it makes perfect sense – If a professional trader runs a penny stocks newsletter and their subscribers are consistently making good money from the stock picks, chances are the subscribers are going to stay subscribed, I mean wouldn’t you? So it’s only in the newsletter’s best interest to provide top quality stocks picks that yield consistent profits, otherwise they’ll lose all their subscribers in no time (along with their reputation). That my friends is why a subscription based penny stock newsletter makes sense – it’s one of those rare win win situations.
So, without further ado, here are my two best penny stock alert newsletter recommendations:
#2. Timothy Sykes Penny Stocking Silver ($99.95 per month) – Recommended for Advanced Traders.
Why Buy a Penny Stock Index Fund?
I’ve had a few questions come up lately regarding penny stock indexes versus individual stocks and why a trader would choose one over the other. Good question, but first for our beginners’ benefit, let’s define what a penny stocks index actually is. A penny stock index, like other indexes, is an investment vehicle comprised of stocks in the correct proportions that make up a particular section of
a stock market, in this case micro-caps.
How to Buy Penny Stock Index Funds
You can’t actually go out and buy the penny stock index, unless you’re willing to buy each and every stock comprising it, a ludicrous idea in itself. Instead however you can buy what are called index funds which are investment vehicles that closely track a specific index. Though there are some actively managed penny stock funds out there I prefer a penny stock ETF (Exchange Traded Fund). The main difference between an actively managed mutual fund and an ETF is that with an ETF, the fund company is merely trying to replicate the index which translates to much lower management fees and less risk since you’re not relying on a particular money manager’s expertise. Of course some may argue that if the manager is particularly good at selecting penny stocks you can do far better with managed funds but again, be aware then that you’re hedging your bets on a single money manager versus the overall index. To each his own.
Now as mentioned in my other articles, a penny stock can be defined in a number of ways so you shouldn’t be surprised that fund company’s definitions of micro cap stocks vary as well. Some define them as any stock below a certain market cap (e.g. $300 million) while others simply take a set number of stocks from the index such as the bottom 1000 stocks by market cap and call them micro-caps. Regardless of how they’re defined however there a number of excellent low fee micro-cap funds worth considering.
Best Penny Stock Index Fund
One of the most popular, and best penny stock index funds as far as I’m concerned, is the iShares Russell Microcap Index Fund (NYSE: IWC). This index fund is based on the bottom 3% of the US stock market and the main reason I like this fund is its high liquidity and volatility, allowing you to easily day trade it, swing trade it, or even invest in it for the long term. Some of the other microcap funds worth mentioning include the Vanguard Small-Cap ETF (AMEX: VB), the PowerShares Zacks Micro-Cap ETF (NYSE: PZI), and the iShares Morningstar Small Core ETF (NYSE: JKJ).
The great thing about these penny stock ETFs is that like all other ETFs, they trade like regular stocks and can be bought and sold easily within your discount brokerage account. As such, they can also be shorted as a hedge or even bought on margin (though I wouldn’t suggest this unless you truly are a trading professional).
Benefits of Index Funds
So why buy a penny stock fund rather than a group of handpicked penny stocks? Well, it really depends on what you are trying to achieve in your investment portfolio. If you’re looking for aggressive growth but just can’t stomach the risks of individual penny stocks, a penny stock index fund might just be the investment vehicle you need. Though they will certainly not achieve the same level of gains a high potential penny stock pick can yield, they do provide higher growth potential than your average index fund or even blue chip stocks. Another big advantage is that you no longer have to worry about the large amount of risk associated with individual small cap companies since in essence you are well diversified, investing in hundreds of stocks through one investment unit.
Drawbacks of Index funds
The main downside of a penny stock fund however is that, well it’s a fund and no matter how well the fund performs, it can never achieve the same results a few good penny stocks can yield. In other words you’ll never see a fund gain 50% in one day, let alone 1000%, which can definitely happen with the right penny stock.
So in a nutshell, though a penny stock index can make an excellent addition to your portfolio and be used for certain investment strategies, if you’re in the market to make significant returns in a relatively short period of time, there really is no substitute for trading penny stocks. If you do go down the path of individual stocks however, you have to recognize the extra risk you’re taking on and thus should do everything in your power to help mitigate that risk. Use stop losses, limit penny stocks to a small percentage of your stock portfolio, never invest more than 5% of your equity in any one stock, consult a reputable financial advisor, and above all never use money you can’t afford to lose.
One Example of a Good Penny Stock to Watch – GWG
If you’re like most penny stock traders or investors, you’re more than likely always on the lookout for good penny stocks to watch and potentially buy should the stock reach your target entry price. Penny stock opportunities come and go each day however, so instead of just providing you a list of penny stocks to look out for tomorrow (which will be pretty much useless to you the day after), I want to help educate you in the types of attributes to look for in a penny stock so that you are able to form your own penny stock list at any time.
The example I’ll be using to illustrate my points at the present time is Great Western Minerals Group (GWG.V). Disclaimer – I own shares of GWG and will be merely using this stock as an example. What is right for me may not be right for you so always consult with a licensed financial advisor before making any investment decision. Now let’s get started.
The first area I’d like to touch on is whether the stock falls under a sector that is currently favored in the market. There is some truth to the saying “a rising tide lifts all boats”, meaning, if the particular sector you invest in is favored in the market, in general the stocks falling under this sector will do well. So, if you’re trying to decide between two great penny stocks and one is in a hot sector, why not choose the one in the favored sector? – It can only help the stock’s potential. In our example, Great Western Minerals is in the rare earth minerals exploration and mining sector which is presently quite bullish.
Potential for Massive Gains
In addition to being in a bullish sector, the stock should have a very promising outlook in both the short and long term. In our example, Great Western Minerals, if we look at the current situation, China mines over 95% of the world’s rare earth minerals. These minerals are essential to manufacture a large number of products including computers, wind turbines, automobiles, and mobile phones. China has been using their near monopoly of these minerals for political gain, even going so far as to blocking shipments to Japan, Europe and even the United States. One can only imagine what would happen if China stopped shipments altogether to these countries. As such there is a massive push to source these minerals from other parts of the world and promising companies like Great Western, are doing just that. In this type of environment, such a penny stock has the potential for truly massive gains which is the type of penny stock you want to look for. Penny stocks are inherently risky so why not choose one that has a large amount of potential.
Healthy Balance Sheet
Regardless of how great the story is behind a stock, what’s equally important is how the balance sheet looks and particular how much debt a company has taken on. Companies with large amounts of debt and little to no income are high risk so it’s always better to choose a stock that is well financed with large amounts of capital and limited debt. Even better is to find one that is also yielding a profit, though good penny stocks like these are hard to come by especially in sectors like mineral exploration.
Bullish Chart Pattern
Since I’m more of a technical trader, I’d say this is probably the most important point to consider. The first three points I mentioned should help you find some great penny stocks to watch but the chart is what will tell you when to actually buy them.
When evaluating a stock’s chart I like to look at both the short term (past 6 months) and long term (past 3+ years) though I find the longer term chart paints a clearer picture of where the stock is headed. Let’s look at Great West’s long term chart as an example.
As you can see from the chart, there are key characteristics that make this stock attractive. Firstly, in general there has been higher volume as the stock price rises compared to when it falls. This indicates confident buying – a bullish sign. Secondly, the stock was in a bearish downward channel but has since broken free to the upside and now resides in a bullish rising trend channel. Thirdly, the stock’s 50-week moving average has crossed the 200-week moving average, otherwise known as a bullish crossover. I’ve found this crossover pattern in particular to be a very positive sign to a stock’s long term outlook.
So this stock is definitely one to watch but is it one to buy now? Perhaps, however I personally might wait first for the MACD to clearly trend upwards again since it’s currently threatening to crossover to the downside which would be bearish.
Of course, I’ve only really touched on a few aspects of technical analysis. To be able to perform adequate TA you really should consider taking a technical analysis course or at the very least, read a good book on the topic – It truly can make or break you as a penny stock investor. As always however, consult with a licensed financial advisor before making any investment decisions.
What is Penny Stock Investing vs. Trading?
I’ve often found that many investors speak of penny stock investing as if it were the same as penny stock trading. This is actually a common misconception, not just with penny stocks but with all other types of stocks. Trading and investing are two completely different methodologies for building wealth, each with their own advantages. Thus, it’s important to understand the difference between the two and then decide whether you are penny stock investor or trader.
Penny Stock Trading
Trading penny stocks is probably the most popular of the two models, not because it’s any more profitable long term but because you can make a lot of money in a short period of time. The problem is of course that it’s a two-edged sword in that you can equally lose a lot of money very quickly. Penny stock trading methodologies include intra-day trading, swing trading, momentum trading, technical trading, even fundamental trading. Each of these techniques have their own pros and cons but the point is that they are all executed either within the same day (i.e. day trading) or over the course of a few days or weeks. Trading penny stocks is not for the weak of heart – you have to continually monitor your trades via level 2 quotes and be prepared to get out at a moments notice.
Penny Stock Investing
Investing in penny stocks is a completely different animal altogether. After searching for some good penny stocks with greater than average growth potential, you buy and hold them for months, even years at time. It may seem risky, even absurd to some traders to hold penny stocks for that long but that is probably because they are traders, not investors. Remember, just because a stock trades on the pink sheets or has very low capitalization, it doesn’t automatically mean it’s junk. There are plenty of penny stock investment opportunities out there with potential for high gains over the long term, you just have to know how to find them.
How to Invest in Penny Stocks
So how do you invest in penny stocks? Firstly, read my post on the finding the best penny stocks to buy in order to better understand what makes a quality penny stock. Secondly, consider consulting a good penny stock broker, penny stock analyst, or even subscribe to a reputable penny stock newsletter. Lastly, only buy companies you can understand. What I mean by this is if you work in the mining sector you probably have a pretty good idea of what to look for in an up-and-coming mining or exploration company but if you’re in the food industry, don’t even pretend to guess which gold penny stocks look promising. Instead, focus on what you know and you’ll already have a built-in advantage.
Consider a Penny Stock Fund
Another good option for those of you who want to invest in penny stocks but have very little expertise in finding good penny stocks to watch, is to consider a good penny stock mutual fund or ETF. An ETF stands for Exchange Traded Fund; they are essentially funds that closely follow a particular index or sector with much lower expense ratios than managed mutual funds. The advantage of investing in something like the Russell Microcap Index ETF (IWC on the NYSE) is that you can add it into your portfolio and leave it for the long term without having to frequently monitor it. This way you get the excellent growth potential from emerging penny stocks without the excessive risk and maintenance.
4 Common Strategies For Day Trading Penny Stocks
Out of all the various trading strategies out there, day trading penny stocks is probably one of the most profitable and risky. In simple terms, day trading penny stock involves buying and selling a stock within one trading day. In other words, you would start and end the day holding only cash with no open stock positions. Intra-day trading is inherently risky yet when done correctly can also be extremely profitable. Like all things, especially in the world of investing, the higher the risk the higher potential reward.
Once a few good penny stocks have been short listed, when trading penny stocks there are some basic strategies traders will typically use to help minimize risks and maximize gains:
Find a Penny Stock Broker That Suits Your Trading Style