Learn the benefits of investing in the best penny stocks and understand the disadvantages, such as market volatility.
In this article:
- The Pros of Investing in Penny Stocks
- The Cons of Investing in Penny Stocks
- Adding Penny Stocks to Your IRA with These Tips
Consider This Important Information Before Investing In Penny Stocks
The Pros of Investing in Penny Stocks
Before you start looking for the best penny stocks, know the pros and cons. Investing in penny stocks has several complexities that go with the lower stock price but also has its benefits too.
Usually, a penny stock is a stock that trades under $5 per share. You usually find this type of stock in the Pink Sheets or on the Over-the-Counter Bulletin Board electronic exchanges.
You can have instant wealth with penny stocks, or you can lose your total investment. If you’re careful as to which companies you invest in, you could make a lot of money — even millions.
Many of the companies are legitimate start-up companies or other legitimate companies that may have been undervalued by investors. These are the stocks that may multiply in a short time.
1. Good Penny Stocks Are Stable
The “good” companies that are trading for “pennies” generally have a proven management team, a growing market share, and solid financial positions. It can show improving financial ratios and often have a service or product that will dominate its industry.
What is a financial ratio? It refers to the relationship between two numerical values. The results can help assess the condition of the business, especially when compared with the growth of competitors.
2. Top Penny Stocks Let You Invest in Emerging Markets
A penny stock is often a way to get into the stock before anyone else knows about it. Often, penny stocks aren’t popular enough for the average trader to invest in.
However, if it does take off, the price can jump significantly overnight. You’ll have gotten your shares before some of the other traders or investors get an inkling of the stock.
This benefits you since the prices often skyrocket once the stock becomes “popular.”
3. The Best Penny Stocks Allow You to Achieve Growth and Buy Stocks at High Volume
Penny stocks allow you to start trading even without a huge investment. You may be able to pick up 1,000 shares of a penny stock at a dollar a share and will make more if that price goes up than if you would make on two shares at $100 a share.
Often, it takes a stock years to make a big price move. With penny stocks, that price move may happen in days instead of years, depending on the company and the product or service that company is offering.
The Cons of Investing in Penny Stocks
Usually, companies with penny stocks have little to no liquidity, very little market and financial information available, and do not have a lot of capital. Other cons include:
- You can easily lose your investment if you choose the wrong company to invest in.
- Some companies that have penny stocks are into illegal activities or may be scams.
- Companies may go bankrupt.
- The companies that have penny stocks are generally low-quality companies. Usually, this is the case because the company’s finances are in shambles, and they’re making large losses.
- Requirements, listing fees, and reporting regulations on the OTC, Pink Sheets, or OTCQX are nearly non-existent. Because of this, these electronic exchanges attract lower-tier companies that can’t meet the rules and regulations of other stock exchanges.
- The valuations gain quickly on some companies but may crash just as fast.
- Penny stocks have different regulations that stockbrokers follow. Often, the brokers charge higher commissions, and some may not offer penny stock trading at all.
- Penny stocks are usually traded much less than larger companies. In most cases, penny stocks might trade a few thousand shares every day compared to larger companies, which could see tens of millions of trades.
- Penny stocks are often “pump and dump” stocks. This means that a promoter loads up on the shares and then tells an investor lies or misleading statements about the stock. Once you buy the stock, you end up losing your money while the promoter makes money off fees and commissions.
- Sometimes scams pop up because of the lessened regulations. Companies are on electronic trading boards with little to no regulations because they wouldn’t be able to list on other trading boards.
Adding Penny Stocks to Your IRA with These Tips
Because of the complexities of investing in penny stocks, including the volatility of this type of stock, it’s not necessarily a good idea to add them to your IRA.
It’s always important to weigh the pros and cons for your own finances to decide if investing in penny stocks is the right move for you.
To learn how to invest in penny stocks wisely, take note of these tips:
1. Go Beyond the Hot Penny Stocks Today
A lot of new penny stock traders or investors usually check out the list of penny stocks to watch when they want to buy penny stocks. There’s nothing wrong with that.
The problem comes in when you fixate yourself with this penny stocks list. Not all of them will be worth the spending and investment.
The simplest solution is to conduct due diligence. Learn more about the business by asking the following questions:
- How long have they been trading stocks?
- What is their status in the stock exchange?
- Can you access their investor’s information and the latest financial data?
- Can you verify their cash flow?
- What’s their image among the consumers and Wall Street experts?
2. Decide Whether You’re Going to Be a Penny Stock Investor or Trader
There’s a difference between being an investor and a trader, and knowing what it is can help you choose the best penny stocks, according to your needs as of the moment.
Usually, penny stock investors are not after earning a profit from the buy and sell of a number of shares in the stock market. Depending on their investor profile or appetite, it may be for capital appreciation, wealth accumulation, or money preservation.
Investors are the ones who are willing to ride the ebb and flow of these stocks since they tend to engage in long-term investing.
3. Be Open to Emerging Markets
It’s unclear whether these will make the best penny stocks in the long run, but if you’re a trader, they make the top penny stocks today due to their demand. In other words, options like marijuana stocks still have a lot of room for growth.
Keep in mind, however, many of these emerging market stocks may have challenges, including regulations.
4. Know the Basic Terms
It doesn’t matter whether you plan to invest with the help of an online brokerage or trading platform app, you need to know the basic terms related to penny stocks:
- Trading volume – This refers to the number of shares the penny stock companies plan to trade in the stock exchange.
- Market capitalization – This is related to the total market value based on the company’s outstanding shares. It’s one of the essential metrics if you want to know the health of the business.
- Those with large market caps, or companies with at least $10 billion cap, are often established businesses. A lot of penny stocks are micro-cap stocks, which is a market cap of $50 million to $300 million.
- Technical analysis – A process that involves forecasting future movements of stock prices using past data. Only two numbers matter here: price and volume.
- Fundamental analysis – An analytical process that aims to determine the stock’s intrinsic value. It considers company earnings, profits and cash flow, competitors, industry conditions, and even politics and government regulations.
- Short squeezes – These are the quick but significant increases in stock prices. It happens when the demand far exceeds the supply.
- Short selling – A technique wherein you borrow the best penny stocks from your penny stock broker to take advantage of the rise of the price. Once the supply goes higher than the demand and the price falls, you buy them back and give them to the broker.
If you choose the best penny stocks to buy today, you can ride with their success. In some cases, the increase in your earnings per share is fast, so you can enjoy significant profits in a short time.
When in doubt, especially on how to buy penny stocks, always get help from professionals such as retirement planners and IRA experts.
Have you tried investing in penny stocks inside your IRA? How’s your experience? Please share your thoughts in the comments section below.
- How To Start Investing In Stocks: The Ultimate Guide | Inside IRA
- Stock Sectors Expected To Gain This Year | Inside Your IRA
- How To Invest In Mutual Funds Inside Your IRA
Editor’s Note: This post was originally published on February 12, 2018, and has been updated for quality and relevancy.