How to Pick a Penny Stock

In this article, I will point out some of the dangers, give out helpful tips and explain how to pick a penny stock.

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Don't be like this guy. Know how to pick a penny stock BEFORE you buy one.
Don’t be like this guy. Know how to pick a penny stock BEFORE you buy one.

Here are 10 helpful tips on how to pick a penny stock. The first thing you have to realize about penny stocks is that they are highly risky and most investors should stay clear of them. However, the volatility of penny stocks also provides the possibility of earning higher percentage gains in less amount of time than ordinary stocks. If you accept the risk of penny stocks it is important that you know what to avoid and what strategies to follow so you can increase your odds of success. In this article, I will point out some of the dangers, give out helpful tips and explain how to pick a penny stock.

Tip 1: Choose an investment strategy.

If your strategy of choice is a value added approach with diversification and a long term outlook on solid stocks with solid financials then should avoid penny stocks. If it’s a long term strategy you seek, you should go here to learn more about blue chip stocks.

If your are looking for a short term strategy more geared towards being a day trader or a swing trader then keep reading because the following tips will be extremely useful.

Tip 2: Only trade penny stocks that are listed on Nasdaq.

Many penny stocks are listed on pink sheets and OTC. In general it is best to avoid these because they are not regulated like they are on Nasdaq. With that being said you can still lose money on penny stocks listed on Nasdaq. Thus, it is important that you choose penny stocks carefully.

Tip 3: Try to Find Penny Stocks that Cost Between $1 and $10 a share.

Penny stocks that cost less than $1 a share are simply too risky for most traders. In contrast, once penny stocks go above the $10 mark they start to leave the penny stock stratosphere so the whole point of trading a penny stock begins to lose its luster. The main goal here is to find stocks that have enough volatility for a short term strategy. This leads to the next tip.

Tip 4: Find Penny Stocks With High Volatility.

Highly volatile stocks have more price movement. This benefits short term traders because you can buy low and sell high in a short amount of time. Conversely, you can also short high and buy back low in a small amount of time. In most cases, it is not a good idea to hold on to a penny stock for a long period of time because you increase your chances of failure the longer you hold them. This is because many penny stocks are cheap for a good reason. They are not worth holding onto because they have poor financials. So what if you are looking to short them? Is it good to hold onto a short position for a long period of time? The answer is still no.

When you are short on a volatile penny stock they always have the potential of rising or even exploding indefinitely. Just think, if some unforeseen astonishingly good news happens you could be in trouble. Also, if  an effective promoter unleashes a massive ad campaign or even an effective pump campaign you can lose money indefinitely. In addition, the longer you hold the short position on a penny stock with upward price movement the greater your chances become of getting a margin call from your broker. In a margin call your broker can sell your position without warning or consent and you can lose significant amounts of money. If you are shorting a penny stock you need to “watch it like a hawk”. That’s why shorting penny stocks is often left to the experts.

Tip 5: Make sure you only risk capital you are willing to lose and have extra money saved up that you don’t need.

If you intend to trade penny stocks with every last dollar you have managed to scrounge up you have almost no chance of succeeding. You should only trade penny stocks with extra cash you won’t miss. There is a good reason for this.

If you try to trade penny stocks with a small amount of money that you have managed to save and expect to make it big by using a margin account (meaning borrowed money) you will have no flexibility with price action. This is because most brokers will not allow you to hold a position overnight with penny stocks. They can and will often sell your position around 3pm without you even knowing it. If you are down at 3pm then you lose period. It’s that simple. It is best to avoid Trading Penny Stocks With Borrowed Money! 

Tip 6: When risking money you are not afraid to lose on penny stocks you have an advantage.

You can hold a position over night if things go wrong. This basically means that if you fail at day trading a penny stock you can try your hand at swing trading it. This also allows you the opportunity to buy more shares the next day or a few weeks later at a lower price thus lowering your price per share. If the stock eventually goes back up you can break even or even make a profit. However, keep in mind averaging down your cost per share by buying more shares at lower prices can actually make matters worse if the stock continues to drop indefinitely. This leads us to the next tip.

Tip 7: Know your exit points, especially know your stop loss point. 

Before you buy a penny stock you must have a price in mind for your exit points. This will help you avoid making emotional mistakes. What I mean by this is don’t be stubborn if things do not go as planed. When a stock hits your stop loss you should get out, minimize your losses and move on without being emotional. If you make nice gains on a stock and reach your target point do not be greedy. Get out at the predetermined time. If the stock goes up more after your exit don’t get emotional. Simply set your points, execute and move on.

Tip 8: Know Hot Sectors

If all the biotech stocks are getting hot then consider a biotech penny stock. If all the solar stocks are dropping then avoid a penny stock that is a solar penny stock. With this strategy take a macro view on a hot sector and then choose a penny stock that you feel good about.

Tip 9: Anticipate Product News

The key to choosing the right penny stock is research, research, research. The more you know the better. In this strategy the idea is to know so much about the penny stock that you have a good idea of when positive product news is coming before you buy the stock. You do not want to buy a penny stock and then hope for good news. Buy a penny stock because you anticipate good news.

For example, one of my secret strategies is to invest in biotech penny stocks. What I like to do is find out when biotech penny stocks are about to release phase 3 testing results. Phase 3 test results are typically the final testing phase of a drug trial. The dates are published online so I like to look for biotech penny stocks that I know have passed tests 1 and 2 and I know the expected day for the phase 3 results. I also research to make sure that the chances of positive phase 3 results is high. It takes a lot of time and patience but knowing how to anticipate positive product news is important. Most investors wait for the news and then it’s too late. The prices on penny stocks can explode overnight so you have to get in before it’s too late. This leads to the last tip on how to pick a penny stock.

Tip 10: Timing is Everything

Often more important than a penny stock itself is the time you buy it. As I said before the key is to anticipate price movement. Consider using technical analysis and research to determine the right time to buy a penny stock. Don’t buy a penny stock the day you find one you like. Be patient, study the charts, know the indicators and strike at the right time. Don’t chase a penny stock wait for the right time to present itself to you.

Also, remember this: never overtrade a penny stock. If things do not go your way with a penny stock it is easy to get emotionally drawn in. What I mean by this is you may get frustrated by a penny stock and say to yourself, “I am going to buy it again and this time my strategy will work.” The chances are it won’t. This is often an emotional reaction. Sometimes it’s best to acknowledge that perhaps it’s time to sit back and plan a new strategy and look for a new penny stock.

What are your thoughts on how to pick a penny stock? If you have any ideas we would love to hear them. Remember that the Trade Locker is a free online community where traders can network and learn from one another so we need your help. Also, don’t forget to check out our new stock message boards. It’s a great place to keep up to date on the latest news about any stock on nasdaq.







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