Ask a financial advisor and a likely ten out of ten they will turn your core holdings into reliable, well-established blue chips. While this asset class is rated highly for overall stability, it does not have nearly the upside potential of penny stocks.
Penny stocks are often derided as casino games and have a bad reputation. Investing in small businesses under $ 5 per share is certainly a high-risk, high-return business. Even so, amateur observers usually have the wrong idea about this market segment.
For one, some of the largest companies in the world like Microsoft and Apple started out as penny stocks. This moves on to the second point: not all penny stocks are inherently trash investments. All you have to do is learn how to research and analyze this speculative category to decipher winners from losers.
Of course the market is a dynamic environment and you are not going to get them all right. However, with proper money management, you can use these tips for greater success with penny stocks.
Watch out for the spread
Before embarking on a speculative trade, you need to consider the spread, or difference between the bid and ask prices, of your target stock. You may find that blue chip stocks have tight spreads, which indicates high liquidity. And high liquidity means low risk, as you have reasonable assurance that a buyer will be available when it is time to sell your stocks.
In contrast, penny stocks have wide spreads, which means you may have trouble selling your stocks when it’s time to withdraw. Hence, it is better to choose names with narrower spreads compared to other penny stocks. And be sure not to get greedy. Obviously, when demand is strongest, buyers are most numerous.
Always remember: you can win on paper, but it doesn’t mean anything until you realize those wins.
Ignore the basics and go technical
One of the main reasons professional financial advisors almost never consider penny stocks for their clients is because the old rules don’t apply in the speculative ecosystem. While metrics like earnings growth and no-charge cash flow may be comparable to a caffeine push for the established Wall Street guys, they won’t provide much information for high-risk publicly traded companies.
In all fairness, a lot of penny stocks have bad financial data as they are usually in the early growth stages. Hence, it is better to rely on technical analysis or the interpretation of chart patterns.
Fortunately, while it is impossible to capture the entire essence of the technical approach in a blurb, penny stock traders have access to a library of free literature. However, if you just learn the basics like the bearish head and shoulders pattern or the bullish pennant pattern (continued), you can separate the duds from the rivets.
Consider the short squeeze
While the best penny stocks offer unprecedented profitability over a very short period of time, one major hurdle is that this market is saturated with competitors. To find viable opportunities without wasting valuable time on low probability matters, consider using filters that only look for stock units that meet certain criteria.
Some of the most fascinating are stocks with a strong short interest. Advanced traders benefit not only from positive trajectories, but also from downward movements in a practice known as short selling. Basically, short selling a stock involves borrowing stocks from a broker and selling them immediately on the open market. Hopefully the price of the stock will go down, where you can pick up the borrowed stock at a discount, return it to the broker, and pocket the difference.
However, there is a risk that the stock in question could appreciate in value. In this case, short sellers buy back borrowed stocks for a premium to reduce their losses (since stocks can theoretically go higher indefinitely, short sellers risk unlimited losses). This buying pressure results in a short squeeze, and if you choose the right short squeeze candidate, you can make incredible profits.
An opportunity for the prepared
While penny stocks trading presents significant risk for the average investor, it also presents an opportunity for incredible profitability for well-prepared investors. Like anything worth pursuing in life, you must be willing to get the job done and exercise money management discipline. If so, this segment of the market may be both satisfactory and financially rewarding.