How to Invest in Penny Stocks

Learning how to invest in penny stocks involves managing risk, volume, and reward.  Because you'll likely be making frequent trades of many shares, it's best to choose a stock broker that charges the same amount of commission for large share orders. Some only allow 5000 shares for the same rate, while others give discounts for 10,000 shares. Finding a good broker is they key to success, as choosing the wrong stock broker could cost you more than you think in trading costs. Buying 10,000 shares from a stockbroker that only allows 5000 share purchases and charges you a half cent fee for each addition share means you'll pay $50 extra per trade when you could have paid less than $10 at another broker.

Diversification is Very Important

Diversifying your penny stock investments between a variety of companies is important. Understanding that the majority of penny stocks fail, you will need to have enough capital and enough investments to be able to find a winner. Putting all of your allocated dollars into one penny stock is akin to taking a turn at the roulette wheel; buying 25 penny stocks with 4% in each gives you a much better shot at succeeding.

Do Not Overweigh Penny Stocks

Penny stocks should never count for more than 5-10% of your overall portfolio. They are risky, and it would be dangerous to put your future retirement on the growth of very small companies. Realize the risks and allocate a small amount of money, which will likely be enough to buy many shares in penny stock companies. It doesn't take much money to build decent positions in penny stocks, so large amounts of capital generally aren't needed.

Set Big Targets

Set large profit targets for penny stocks. Investing in penny stocks like you would blue chips simply doesn't make sense. You can churn 20% profits in blue chips just as easy as you could with penny stocks, and thus, you want to ensure your goals for trading penny stocks are larger than the returns for less riskier instruments. Investing in penny stocks should result in huge gains - not small intraday or 10% gains. Trading penny stocks for minute gains is made difficult by the limited amount of volume and liquidity in the stock market for stocks with small prices.

Don't be Fooled by Stock Price

Just because penny stocks have small prices doesn't mean they aren't quality businesses. In many cases, they're small businesses that simply outgrew their owner and needed some expansion capital. Right now, there could be hundreds of penny stocks that will soon be the corporate giants of tomorrow to replace the corporations of today. Finding a quality penny stock might be difficult, but the good ones often turn out to be the diamonds in the rough. The returns that can be enjoyed from penny stock investments are generally larger and far outweigh the research required to find quality companies.

Look for Earnings Growth

For small cap stocks, earnings growth is incredibly important. If you can't obtain high double digit growth rates, you're better off investing in larger companies with more stability. Otherwise, high growth rate penny stocks are best, but don't settle for tiny growth rates in companies that carry more risk.