How to Research Stocks: Tactics for Thorough Stock Research

Introduction

Penny stocks are securities of small companies, typically valued at less than $5 per share. Some of these stocks are traded on major exchanges, including the New York Stock Exchange (NYSE) and NASDAQ, but most are traded over-the-counter (OTC). 

This article delves into how penny stocks work, the advantages of investing in the asset class, and the risks you may encounter. Ultimately, you will understand how to buy penny stocks.

Highlights and Key Takeaways

Let’s explore the key points regarding how to buy penny stocks:

• The percentage change in the price of such stocks is higher than that of securities from larger enterprises. Despite being called “penny” stocks, the asset’s value can fluctuate two or more times within a short period. 

• Most brokers have stricter requirements for penny stocks trading and investing, especially the margin for opening a short position. Therefore, selling long is better when trading such assets.

• Making a profit with penny stocks is easy, but traders can also lose capital quickly due to unfavorable market conditions.

Understanding Penny Stocks

What are Penny Stocks?

Before delving into how to buy penny stocks, exploring the basic concepts related to the asset class is crucial. Brokers generally classify stocks priced at less than $5 as penny stocks. However, it’s important to understand that this amount may vary. In the past, the US government categorized securities in this class with prices up to $1, but later increased the rates. Majority penny stocks are traded over the counter. The market capitalization for penny stocks does not exceed $300 million.

• Apart from their low price, penny stocks have other distinctive features. The securities are often traded outside the traditional stock exchanges or exclusively on the over-the-counter (OTC) market.

• The liquidity of penny stocks is significantly lower than that of regular stocks, especially blue-chip stocks.

• Companies issuing penny stocks must either undergo a simplified procedure for state registration before they can issue the security or may be exempted from the procedure for various reasons.

• Information about the activities of a company issuing penny stocks is less readily available than that of stock companies listed on main exchanges. Sometimes, obtaining accurate information about a company can be quite challenging.

The Appeal and Risks of Penny Stocks

The Appeal Penny Stocks:

• Сheap pricing. The cheap price of penny stocks is a primary factor attracting investors. Since these stocks usually trade for less than $5 per share, anyone can purchase them. In other words, penny stocks may be desirable by investors on a restricted budget since they require a relatively small investment.

• High volatility. The values of penny stocks are prone to sudden and sharp fluctuations, which is why they are highly volatile. Some investors may find this off-putting, while others may see it as a chance to generate significant profit. For instance, investors who purchase a penny stock early might make big returns quickly if it suddenly sees a jump in price after a significant market update or announcement.

• Possibility of large profits. The possibility of massive gains is another factor that draws investors to penny stocks. Though there are many risks associated with trading or investing in penny stocks, the security provides an opportunity for investors to make substantial returns. This is because penny stocks can suddenly soar in value.

Risks of Penny Stocks:

• Limited Information. There are instances where companies offering penny stocks are exempted from filing their financial reports with the Securities and Exchange Commission (SEC). Also, most  companies that offer penny stocks are new and have limited historical information.Given this lack of information, investors may find it challenging to make informed decisions before buying a stock.

• Low Liquidity: Most penny stocks are traded over-the-counter. As a result, the liquidity is low. In emergency situations, you may be unable to find buyers and liquidate your investment.

• Scams and Fraud. Scammers and fraudsters who want to earn a fast profit frequently target penny stocks. Pump-and-dump schemes, insider trading and incorrect or misleading information about the firm are some of the ways these frauds might take place. For instance, the stock’s price may be artificially inflated, making an investor sell his or her shares and incur losses. 

• Absence of Regulation. Penny stocks are not subject to the same regulations compared to the equities on major stock exchanges. The absence of regulations may encourage stock price manipulation and investor deception.

How to Choose Penny Stocks

Researching Penny Stocks

To minimize risks when buying penny stocks, traders should conduct a thorough research and analysis of the stock they want to purchase. We have compiled a little checklist that may help you with the process:

Key criteria for selecting Penny Stocks include:

• The stock should have a price of $5 or below. 

• The average trading volume over a 20-day period should be 200,000 shares or more.

• The total sales volume and purchases in a week should be significantly higher than that of the previous week.

• The total volume of sales and purchases of the stock from a week ago should be greater than the previous two weeks ago.

• The current price should be higher than that of a week ago.

• The stock price from a week ago should be higher than its price from two weeks ago.

You can consider several factors when choosing a penny stock issuer. These companies are often characterized by the absence of high sales, large debts, negative financial reporting trends and poor fundamental indicators. 

It is advisable to work with stocks with a decent increase in prices and demand in recent weeks. After selecting suitable securities, evaluate them using both fundamental and technical analysis. Note that the best stocks are more suitable for short-term transactions.

Understanding Market Trends

You can only succeed in the financial market if you are informed about all the trends that influence the markets. Like other investments, you can stay updated with penny stocks by keeping tabs on the news. Global events and updates can impact the price of a cheap stock. So you can leverage the right information when trading.

There are several ways to stay informed about events in the financial market and market trends. You can start by visiting market-focused websites and financial magazines. The sources often release essential information about specific companies or industries first. You can study press releases and presentations of new products and services to access financial reports. 

Don’t forget legislation. Any change in the regulatory framework for penny stocks can affect asset value. An adequate knowledge of legislation and tracking the latest changes in this area will inform you on when to adjust your preferred trading strategy to minimize the risk of financial losses.

Also, remember social media. In the world of digital technology, social media platforms remain the primary sources of information about a particular company. Through social media comments, you can learn people’s opinions about a penny stock or the issuing company before investing.

Investing in Penny Stocks

Building a Diversified Portfolio

The process of spreading money over a portfolio of several asset classes (stocks, bonds and other instruments) to lower risks is known as investment diversification. It is better to split your budget across different stock selections when dealing with penny stocks instead of putting all of your money on one stock. Diversification will help prevent losing your capital at once if an individual stock performs poorly. 

When building a diversified portfolio, choosing assets with little to no connection with one another is critical. For instance, increased oil prices may cause the price of some assets to rise, and others to fall. By leveraging the gains from one investment, you can shield yourself from market volatility and huge losses when another asset falls in price.

Setting Realistic Expectations

Remain realistic with your expectations when considering how to purchase penny stocks. While believing in the asset’s advantages is a good idea, it is essential to recognize the significant dangers associated with the stock trading industry. Things are always likely to go two ways: either you make money or you lose your investment.

It’s critical to remain patient and consider the circumstances unbiasedly. If your selected approach isn’t working, you should find alternative strategies.

Conclusion

Now, you know how to buy penny stocks, their advantages, and the risks of such investments. If you’ve decided to invest in this area, carefully analyze a specific stock and find enough information about the company offering it. Such a responsible approach to trading will help reduce potential risks and prevent falling victim to fraudsters.

FAQ

Can You Get Rich Off Penny Stocks?

One can become wealthy by investing in penny stocks, but there are no guarantees. It is pertinent to note that while penny stocks can turn small capital into a huge amount, they can also wipe out your investments quickly. When working with penny stocks, it is crucial to diversify your portfolio to protect you from significant losses if some investments fail.