How to Buy Penny Stocks?

How To Buy Penny Stocks

Once you've learned to dodge scammers, here are five steps to 

follow when purchasing a penny stock. It's important to evaluate 

whether the stock has upside potential: You're investing because 

you'd like to get a return, right? So you need to ask yourself whether 

the penny stock you're considering truly has upside potential, or if it 

seems more to be a flavor-of-the-day kind of stock, such as a company's 

that's trying to ride the coattails of the latest investment fad. You should 

devise a realistic risk-reward assessment for the stock, even if you're only 

investing a few hundred dollars in it.

Limit your holdings and diversify: You might be excited about the 

prospects for your favorite penny stock, but you still need to protect 

yourself. Cap your losses by limiting your holdings in the stock to no 

more than 1% or 2% of your overall portfolio. It also makes sense to 

diversify your penny stock portfolio, which shouldn't exceed 5% to 10% 

of your overall portfolio, depending on your risk appetite.

Check liquidity and trading volumes: Even if you've made a successful 

investment in a penny stock, you're going to need to be able to sell your 

shares. You should have adequate liquidity and trading volumes in the stock 

so that you can trade it efficiently. Otherwise, you may wind up in a situation 

where there are few buyers and wide bid-ask spreads, making it nearly 

impossible to convert your paper profit into an actual one.

Know when to sell: It's very rare for a penny stock to be a long-term 

buy-and-hold investment. The sector is built on short-term trades, so it's 

as important to know when to sell as it is when to buy. If you notch 

sizeable gains over a short period in a penny stock, consider booking 

them now rather than waiting for bigger profits that may never materialize.

Search for high-quality stocks: Basically, some penny stock companies 

are worth more than others. Good prospects include ventures that are set 

up by experienced managers who have successfully exited a previous 

company; stocks with binomial outcomes (such as biotechnology stocks 

or promising resource companies) and fallen angels. If getting a low stock 

price is driving your investment decision, then fallen angels – which appear 

in abundance towards the end of a bearish trend, whether in a specific 

sector or the overall market – are among your best bets (although strictly 

speaking, they're not really penny stocks). Many leading technology stocks 

today were trading in the low single-digits at the end of the 2000-02 "tech 

wreck," while household names like Citigroup Inc. (C) and La-Z-Boy Inc. 

(LZB) traded below a buck in March 2009.