As you probably already know, penny stock investing is very risky. In fact, it is probably the most dangerous investing method of all. And it is also very profitable. Nothing beats being an owner of a stock, whose share price went from $0.12 to $22 in a few weeks. But not every penny stock trading is the same. There are as many techniques as there are investors, though we can identify three major strategies that are the most common. You definitely should consider choosing one of them, and then refining it further to match your trading style.
1. Cheap Stocks On Major Stock Exchanges
By common definition the shares of penny stocks are trading below $5. There are really many stocks like that on major stock exchanges, like the New York Stock Exchange (NYSE), NASDAQ or AMEX. Trading these penny stocks is just as safe as trading any stock on these exchanges. Stocks listed on major exchanges have to undergo very strict reporting requirements, so you can be sure those companies mean business. They are not some shell companies started for whatever dubious reasons, but established businesses with a past and a future.
All this may seem safe enough, or at least not riskier than regular stock trading. However you have to consider one major drawback before deciding to follow the path of trading cheap stocks on major stock exchanges.
Companies that want to be listed on NYSE, NASDAQ or AMEX have to pay astronomical listing fees. So, penny stocks you find on these exchanges are probably not small companies just starting out in hopes of making it big. Most probably they are once large companies, whose share price plummeted because of financial troubles or some other dire reasons. Just take Sprint (S) for example, listed on the NYSE. In the year 2000, at the peak of the dot-com craze, the share price of Sprint went to $75, only to reach the lows of $2 in 2012. As of October, 2014 it is trading at around $6.
Your main job when utilizing this method is to find out why a certain penny stock is trading on such a low share price. You have to believe in your chosen stock, that despite the bad times it can still soar in the future.
2. Stocks On Over-The-Counter Markets and Pink Sheets
On over-the-counter (OTC) markets and Pink Sheets you won’t find companies that were once big but have fallen from grace. These penny stocks are usually really small startups with a share price below $1. There are thousands of them, and you cannot ignore the research necessary to filter out those 95% of them which are useless. OTC penny stocks have other kinds of risks altogether.
They are extremely illiquid. Not many shares are traded daily, so if you buy a stock on an OTC market, later you may find yourself in a position that you simply cannot sell it for profit, because of the low volume and a large spread between the bid and the ask price. You won’t be able to find a buyer.
The other risk is that the great majority of stocks on OTC markets are really low quality, junk stocks, and only a few of them are worth further research. Knowing how to find the good ones is the key point.
3. Ride The Pump And Dump
This is unquestionably the most dangerous strategy. Penny stock trading gets all the bad press primarily because of the pump-and dump schemes.
Pump-and-dump is a very common and unethical (even criminal) activity where scammers buy up the majority of shares of a low quality OTC penny stock, and then they promote it heavily, so that gullible investors buy the stock too, thereby driving up the share price. When the share price has rocketed, the fraudsters simply sell their shares, causing the immediate collapse of the share price, leaving the investors with a worthless penny stock, unable to recover.
The question then is can you profit exploiting this fraudulent activity. There are two ways. The first way is probably unethical, but the second way will make you the king of penny stock trading.
The first method is to identify a pump-and-dump scheme as early as possible, and get in while the share price is still rising. Even more importantly you will have to get out before the share price collapses. In other words, you are doing exactly what the scammers are doing with the stock, only with much less information. This, of course, is a very risky strategy, and probably an unethical one, because – if you are successful – you are clearly taking the money from the victims of the scam.
The other much more exciting technique is to short the pump-and-dump penny stock at the exact moment, when you are sure the share price has reached its peak and the collapse is imminent. This is how Timothy Sykes, the famous penny stock millionaire made $3 million out of $12,000 in a couple of years. If you are good at technical analysis and have access to appropriate research tools, you can screen for possible pump-and-dump penny stocks and go against the crowd by shorting them.
Whichever strategy you choose, always keep in mind that you are sailing the most dangerous waters of investing if you are dealing with penny stocks. Learning and researching is important in every type of investing, but in the case of penny stocks it is absolutely crucial. Always do your homework and your rewards will be big and fast profits. Good luck!