Picking Penny Stocks

There is a great deal of assistance on the Internet specifically about picking penny stocks. While there are a few trustworthy resources for information, unfortunately there are far more that are downright unscrupulous and self-serving. Would you trust a food critic’s restaurant choices if you knew the restaurant gave them a hand full of gift certificates to promote them? Probably not; yet every day investors believe in picking penny stocks based on what a blog or newsletter touts never realizing that the source of the advice was given shares or even cash to promote that company’s stock. When they own a company’s shares, why wouldn’t they hype it up to drive the price up? It is estimated that 75% of the websites and newsletters available are nothing more than paid advertisers. It may take some digging to find a reputable advisor, but it can easily make the difference between a successful and enjoyable experience in the penny stock investment world and a disastrous financially ruined outcome.

The next step after you have found a reliable source for stock picks is to decide on a stock broker. There are two types of stock brokers – full service and discount.

  • Full Service Brokerages
    • Advantages
      • Clients receive personalized attention from a broker or team of brokers
      • Your broker or team knows your goals and can thus advise you and give recommendations that fit your investment goals
    • Disadvantages
      • Such service is costly; commissions can run $100 or more per trade and many brokerages have extra fees involved for penny stock transactions
  • Discount Brokerages
    • Advantages
      • Lower fees and commissions; many are “penny stock friendly”
      • Usually include online account or automated telephone service thus you have 24/7 service
      • Usually available to answer questions
    • Disadvantages
      • Do not receive personalized attention
      • A few have unreliable websites or delayed transactions

Once you have settled on a brokerage account you can set up your investment account. This is generally very simple to do and can often be done online by inputting the required information and transferring funds from another bank account.  Be sure to set up your login information carefully to avoid it being easy for a hacker to obtain access. Do not make your password something easy to guess and never share it with others. Be sure to write the information down in a safe place. It is not a bad idea to regularly change your password as well.

The next step is actually picking your penny stocks. Although there are investors that will tell you they choose stocks based on their gut feeling, the reality is that experience has taught their gut what looks good. You will not have the luxury of experience at your disposal for your initial choices. Thus you will need to rely on those reputable advisors already mentioned. Granted you can go it alone and learn on your own thru trial and error, but unless you have a portion of your portfolio you can safely lose, this may not be your best strategy. The better advisors are going to use some of the following techniques when choosing penny stocks:

  • Hyped or Promoted Stocks – These are stocks that have forces at work purposely driving up the price of the shares even though the stock itself is not really worth very much. This situation results in a “hot potato” scenario in which all the investors make a nice tidy profit EXCEPT the poor guy holding it at the end. An advisor can help you spot these shares but more importantly tell you when to get out.
  • Trading Cycles – There are any number of technical indicators that advisors can use to determine when a stock has more of a probability for gain than it does for loss. Sometimes there is more than one indicator in place making a particular stock extremely desirable.
  • Financial – Certain financial elements will indicate how strong or weak a company is. An analyst will look at a number of figures and ratios to make a determination; such as debt ratios, net assets, P/E ratio and so forth.
  • Leadership – An advisor will also look at the overall plan of the company and if those in key leadership and management roles are well suited to make those plans a reality.
  • Value – Obviously the most room for profit is in the most undervalued stock that has much room on the way up for some nice returns. Spotting these companies takes experience however. Being able to identify the reasons why a share may have taken a sharp downturn will make the difference between knowing to hold on to shares for the anticipated upswing or dumping them before they hit bottom.

If you use many of these same techniques, you should fare better than someone that takes the “dartboard”  approach or relies on untrustworthy advice. The problem with doing any of this on your own is that you may not have the resources for information available that an advisor will have. The good ones often subscribe to news sources and take advantage of sophisticated software that uses complex algorithms to evaluate data and other sources of information.

One of the things you can do to minimize your risk is to learn how to recognize scams and those probable to become worthless. If you spot any of the following red flags, you should not invest in that stock:

  • Use of gimmicky sales tactics
  • Has been suspended from trading by the SEC at any point
  • Insiders own much of the stock
  • Accountant refuses to certify financials
  • Peculiar footnotes to the financial statements
  • Inconsistent sales volume
  • Very low sales volume
  • Unrelated assets meant to give impression of stability
  • Broker will not give you written information
  • Promises that sound too good to be true

Investing in penny stocks can be interested and sometimes rewarding, but it should never be something you invest your entire portfolio into. Have a clear plan of your objectives and do not let emotions override your common sense.