A penny stock is usually defined as a stock that trades at a relatively low price outside the major market exchanges. Penny stocks are highly speculative and high risk because the companies lack liquidity, have small capitalization, and limited following. Traders commonly refer to any stock which trades for under $5.00 or a stock that trades off the major markets as penny stock. Companies that offer penny stock tend to be small, and are subject to limited listing requirements, filing, and regulatory standards. Most penny stocks are traded over the counter (OTC) through stock quote services.
Penny stocks are attractive for investors who don't mind a higher risk. Since the companies that offer penny stocks may have a high debt to liquidity ratio or limited assets and lower earnings, there is more risk involved when purchasing the stock. The low prices of penny stocks are appealing to many investors because they can purchase a large quantity of the stock for a low price. If you are buying a volume stocks for $5.00 a share, modest gains can begin to add up quickly.
In order to be a successful penny stock trader, you need to create specific guidelines for buying a stock. Whatever you are using to guide your purchasing, stick to your criteria and don't stray from it. Use this formula to help you decide when you should sell your penny stock. Know when to get out, and don't let your losses pile up. Be disciplined in your trading.
When selecting your penny stock, only buy stocks with good volume. It's too difficult to get in and out of a position if the stock is only trading at a minimum volume per day. Many penny stock trading experts recommend trading stocks with an average of at least 1,000,000 shares every day.
Do some research on your potential investment. Since penny stocks are not regulated as closely as traditional stocks traded on a major exchange, you need to know exactly what you are putting your money into. Have a solid understanding of the company's business model and financials. Many companies pay investors and writers to promote their company, in order to raise stock prices, so be judicious about where you are getting your information. Stock advice and tips that come unsolicited via email, social media, and "snail mail" will most likely be biased and not provide you with the whole financial picture of the company. Very rarely should you act upon the recommendations. You will want to do your own, un-biased research.
Diversification is as important with penny stocks as it is with more traditional stock. Develop a strategy that allows you to invest in a number of different companies. Never put more than 20 percent of your money in any single company.
Take advantage of stop orders. Make sure you have a standing stop order in place for your portfolio. When dealing with penny stocks, a market downturn can drain your account quickly. Although there's potential for growth with these investments, there is also a potential for big losses.