In the past three articles, we have reviewed the nuances of the penny stock world, the pitfalls to avoid, particularly fraud, and now, after feeling a bit more confident about the idea, isn’t it time to buy a few stocks? Absolutely, NOT! Would you let your fifteen-year old jump behind the wheel of your car after only reading the Drivers’ Manual? No, of course not. Trading in penny stocks is a new adventure, and there are a few more things to take care of before taking the training wheels off this bike.
Believe it or not, there are many similarities in this field to that of foreign exchange market. In that world, successful trading is all about the “PIPS”, industry slang for a movement in price and an anagram that applies to micro-cap investing. “PIPS” translates to preparation, information, practice and strategy. All four areas a required, and no shortcuts are allowed. In the forex world, 60% of all beginners lose their capital in the first six months, and studies have shown time and again that impatience and reluctance to prepare and practice fully are the key reasons for failure. And even when you manage these tasks, letting your emotions interfere with executing a sound and disciplined trading strategy can then prove fatal.
Penny stock trading is similar, but more difficult than large exchange stocks. There is not a lot of information available on companies. You have to learn what is good and what is useless. Liquidity issues make selling difficult, and volatility is magnified in this world. Stock chart indicators can suddenly render false signals when least expected. Your preparation should include training classes from experts that have made money in this area. Free penny stock investment letters may have useful information in them and they may not. An expert can guide you on how to find and use the correct information that is available. You need to develop the skill to know a bad company immediately and to avoid it. Let the experts teach you how.
Now are we ready to trade? No, not yet! You still must practice. In the currency world, brokers provide free demo accounts and the ability to trade “virtual money” in order to gain experience, confidence and the ability to control your emotions. For penny stocks, you must “paper trade”, sometimes months at a time, to prepare yourself for the real thing. Even when you decide to buy stocks, you should limit your exposure to a small percentage of your entire holdings. The volatility of this market can wipe you out in one violent jerk, much as with currencies. You must allow for this uncertainty from the outset.
Finding penny stocks worthy of investment can be a daunting task. There are thousands of stocks to choose from. Using research, scanning tools, stock picking sites and screeners can help you find that one stock that stands out above the rest. Companies that are growing and do not have huge debts are a good bet. Screen for companies with over 500,000 shares in volume per day, and for starters, only pick companies with revenue and a share price over $1.00. Do not purchase these shares before an earnings release either. These stocks do not have good fundamentals. The least bit of bad news can send a share price off a cliff.
If you stick with market caps over $100 million, you will still have ample companies to review. Reduce this list to 20 companies and follow them closely. Don’t forget to “paper-trade” first, and for a few months. Next up, we discuss your trading discipline and summarize. Stay tuned!