The Best Tips on How to Make Money With Penny Stocks

Stock graph with upward trend, symbolized with a penny
15 Oct 2019
If you are looking to learn how to make money with penny stocks, you should check out these tips. Click here to learn more.

Penny stocks are an enticing option for many people who are looking to grow their wealth. Whether they’re new investors looking for ways to grow newly inherited wealth, or longtime traders drawn by the hopes of a profitable payout, there are plenty of reasons why people try their luck on penny stocks.

But unless you know how to make money with penny stocks, you could be setting yourself for trouble. Though the cost to invest is smaller per share, they’re subject to all the risks of regular investing. For myriad reasons, they’re prone to scams and manipulation by unscrupulous parties.

That makes it all the more important for investors to know what they’re doing before getting into the penny stock game.

Top Tips on How to Make Money With Penny Stocks

One thing to clarify right away is that the definition of penny stock is somewhat murky. Merriam-Webster defines the term as “a usually unlisted highly speculative stock usually selling for a dollar or less”.

Even that definition has built-in exceptions, and opinions vary on what counts and what doesn’t. Some definitions put the ceiling as high as $5 per share.

This distinction can matter a lot depending on how much you’re looking to invest. Keep in mind that we’ve tried to design these guidelines to be as applicable as possible over that range.

With that said, here are our tips on how to safely and successfully invest in penny stocks.

1. Ignore the Big Penny Stock Success Stories

A lot of people hear tales of people who made fortunes off of betting on the right stock when its price was low. Technically, these things do happen. Who wouldn’t go back and invest in Amazon when they were only an online bookseller?

However, the odds of being in the right place at the right time to invest in the next big thing are so long that you may as well invest in lottery tickets.

Instead, you need to treat penny stocks like any other investment and gauge the financial strength of the company before you buy-in. This means looking at a company’s balance sheet.

A minimal amount of debt is desirable but not practical when looking at penny stocks. Most of these companies are in their early stages. Higher risk is the trade-off that comes with lower stock prices.

A good rule of thumb is to only invest if a company’s long-term debt is, at most, equal to 50% of shareholder equity. While that still doesn’t provide any guarantees, it helps to curb some of the risks.

2. Don’t Trust Any “Hot Tips”

There is a whole cottage industry built around artificially inflating the values of penny stocks. Most free newsletters and tip sites get paid to promote the stocks that they’re pushing.

Promoting a company wouldn’t be a problem in and of itself, except that it’s a basic tactic that unscrupulous investors use to pump up the value of shares that they bought on the cheap. Many of these newsletters make false promises to drive the price up as fast as possible, and they’ll never tell you when it’s the right time to sell. Meanwhile, their clients dump their stocks at their peak value, making huge profits while everyone else loses big.

How can you know who to trust? Fortunately, the Security Exchange Commission requires that all these tip sheets provide disclaimers for any paid promotion. Reading the fine print at the bottom of newsletters or articles will help reveal any conflicts of interest.

3. Quit While You’re Ahead

One of the things that make penny stocks so appealing is that they can make significant gains in a short period. It’s not uncommon for some to make as much as 20 or 30% in just a few days.

However, if a given stock starts delivering those kinds of returns, it’s for the best to get out while the getting is good. While a small company could potentially attract that much interest on its own in a short period, the odds are at least as good that someone is artificially pumping it up.

Resist the temptation to wait for a stock’s absolute peak. You’ll kick yourself less for selling early than if you wait too long and lose your entire investment.

4. Don’t Trust Company Management

It seems harsh, but never trust anyone who would ask you to invest in their penny stocks.

In the best-case scenario, they’re honest entrepreneurs who want to take your money so that they can stay in business. Worst case, the stock is a scam invented to enrich insiders. Either way, they won’t be able to provide you with accurate data or a reliable business model, so you have no reason to trust them.

5. Look at Liquidity

A popular tip is to favor stocks that trade in high-volumes, usually at least 100,000 shares traded daily.

Liquidity is an asset for penny stocks. Illiquid stocks are subject to more volatility, as buying a significant amount can easily drive up prices, while trying to sell the same amount can cause prices to plummet.

You want to find stocks that trade enough that you don’t find yourself saddled with a huge chunk of shares. However, when looking at shares that trade in high volumes, you want to beware of sudden surges.

One study found that when high-volume stocks surge in price, the tendency is for them to correct in price thereafter. This means that if you spot a high-volume stock that suddenly surges 50%, you can expect its price to drop down again soon. Unless you already have shares of that stock, you’ve probably already missed the window to buy.

Start Trading, Start Earning

While these tips and tricks can help put you on the right track, the most important thing is to do your due diligence with any stock that you buy. That alone will help you to avoid getting caught up in a pump-and-dump scheme or the like.

It’s possible to turn substantial profits if you know how to make money with penny stocks, but it’s important to remember that even if you do everything right, there are no guarantees.

You can try to play it safe, but all investment comes with risk. As penny stocks are among the riskier options, they may not be right for everyone.

If you’re more interested in saving for retirement than striking it rich, there are more reliable ways to accomplish your goal. Check out our guide on using compound interest investments to reliable grow your savings. If you’re ready to get started now, fill out our online form and start building your portfolio today. 

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