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Important Tips To Consider Before Investing In Penny Stocks

Apr 10, 2008
Penny stocks are a financial subject that a great deal of people, particularly newcomers to the stock market, do not understand. This fact alone is one of the main reasons penny stocks are labeled as a risky venture. Unfortunately, many excellent penny stock companies suffer from this rap undeservedly. Risky is a relative term and can be applied to the larger markets including futures, commodities and options as any form of derivative such as these are considered to be a risky venture, although penny stocks are not a derivative. There is a sufficient amount of risk involved in the larger markets as well, comparable to the penny stock market, if not more so.

Below are some important tips to consider before investing in the penny stocks.

1. Do your research.

Research is probably the most important factor to consider once a person has decided to invest in penny stocks. It is very important to attain as much information as possible on the company beforehand. Granted, there are many shady and unscrupulous characters involved in the penny market, but doing research can often times weed out the companies that may be questionable. Security and Exchange Commission filings are probably the best way to answer the questions a person may have about a potential penny stock company. Reading SEC are filings are a boring and laborious task, but is required if one is to do proper research.

2. Is the company a legitimate business or a shell?

The penny stock market is loaded with companies that trade daily on the exchanges with no viable business operating within them and are called shell companies. A shell company may have all if the required filings up to date with the S.E.C and are a legitimate enterprise in name only. Usually the owners of the shell company are seeking a functioning company to do a reverse merger into the shell or are willing to sell the shell company to a private company trying to go public. Shell companies may not trade for days or weeks at a time so checking the daily trading history of a penny stock company is vitally important.

3. Is the company profitable?

Revenues are what drives the entire stock market. Companies that have no revenue are usually not too appealing to investors, except on the penny stock exchanges. There are many profitable penny stock companies with some preferring to stay on the smaller exchanges rather than moving to the bigger exchanges. More times than not, most penny stock companies are research and development companies that have more of an idea rather than an actual business generating revenues. Here in lies the beauty and attraction of penny stocks. All investors dream of getting in on the ground floor of the next huge gainer, but as stated above, research is the key to finding these future stars.

4. Is the company on the OTCBB or Pink Sheet Exchange?

Ideally if one chooses to invest in a penny stock company, it is better to choose a stock on the OTCBB or Over The Counter Bulletin Board Exchange. Penny stocks trading on the OTCBB are required to have all of their filings up to date and filed on time with the S.E.C. If they are not timely and update in their filings, they risk delisting from the OTCBB and losing their transparency to investors. Other penny stock companies that do not have update and timely filings trade on the Pink Sheet Stock Exchange. The Pink Sheets are a wild an wooly form of investing and is more a form of gambling than investing since there really is no way of knowing the companies internal condition. Technical Analysis is probably the most informed way of making money with penny stocks trading on the Pink Sheet Exchange, although extreme caution is required.

Education and experience are the most important factors when considering penny stocks as an investment or trading instrument. Penny stocks attract many people simply because they are a fraction of what stocks trading on the larger exchanges cost. Most penny stocks trade on these exchanges for a reason, they are extremely speculative in nature and penny stock are better suited for the experienced investors.
About the Author
Phillip Hatley trades penny stocks frequently on both the OTCBB and Pink Sheet Exchanges. Please vist his blog for more information about trading
penny stocks.
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