Looking To Invest In Penny Stocks? 5 Things You Should Know, First
Have you ever wanted to buy penny stocks? I’m sure if you’re reading this, you have at least a little bit of interest in ways to do that. What about investing in penny stocks? Believe it or not, there are ways to do that as well but you need to keep a few things in mind. For starters, do you know what penny stocks actually are?
I’ve read a lot about what others think of these cheap stocks. But the fact is, penny stocks aren’t just limited to a certain exchange and they aren’t actually just stocks under $1. According to the Securities and Exchange Commission, the definition of penny stocks pertains to shares trading below $5. I know it might seem confusing as one might think they should technically be trading for “pennies”. However, this definition likely accounts for the added risks that stocks under $5 hold.
Learn More | Penny Stocks Trading for Beginners 
Now, just because there’s risk involved, it doesn’t mean you should avoid these at all costs. It also doesn’t mean that penny stocks aren’t worth investing in. Are all penny stocks prime candidates for an investment? No, nor should you believe that just because people are talking up/hyping up a certain company as “the next Apple”, it’s a good “investment”. After observing how traders react to FOMO — Fear Of Missing Out — I can say that emotion is one of the top contributors to losing on a winning trade. And that’s exactly what most penny stocks end up being: a trade.
To actually invest in penny stocks, there are several things that need to happen. In many cases, all penny stocks worth investing in don’t start out that way. They might gain attention from a spike in volume or a recent development that coincides with the current news cycle. As things progress, it’s up to the company to meet milestones and grow into a company where fundamentals matter more than simple market momentum. So if you’re looking to invest in penny stocks, keep these topics in mind.
How To Invest In Penny Stocks
- Consider The Price Of Penny Stocks
- Capital Raising Strategy
- Consider The Industry
- Keep An Eye On Your Investment
- Scaling Your Position
How To Invest In Penny Stocks #1: Consider The Price Of Penny Stocks
Obviously, if you’re looking to invest, you have a long-term vision in mind for the company. But since you’re dealing with penny stocks, there are much higher risks as compared to blue chip stocks. One of those risks has everything to do with the price a stock’s trading at. If you buy stocks under 20 cents, for example, a 2 cent move could mean a shift in the price of 10% or more.
So when it comes to investing, higher-priced penny stocks might offer a bit more forgiveness when it comes to volatility. If a $4 stock moves 2 cents, you’re not looking at a massive change in price. This goes for price movements up and down. But remember, you’re looking to invest in penny stocks to quick gains aren’t generally the goal. If that’s your plan, then you might want to consider how to trade penny stocks instead.
How To Invest In Penny Stocks #2: Capital Raising Strategy
Another thing to consider is how the company raises money. Most penny stocks are valued the way they are because the companies are still in start-up phases. As such, it may be harder to raise funds at an optimal valuation as compared to blue chip stocks. For instance, Tesla might raise money through a bond that yields around 5% interest.
In the case of penny stocks, they may raise funds through debt notes or discounted share purchases. In the case of debt, you should consider the price at which the company offered the fund investing in the company. Some companies will raise money with specifics pertaining to conversation rights.
This is when the investment fund converts their debt into shares in lieu of repayment from the company in cash. In these cases, we see funds converting their debt at massive discounts to specific market conditions. This might entail converting debt into stock at a 50% discount to the lowest 3 trades in a rolling 20-day period. An example here is a stock trading at $3 might have 3 “low prints” in a 20 day period at $2.50.
Even though on the day of conversion, that same stock is trading above $3, the fund can still convert their debt into shares at 50% of $2.50. That means they own shares of “Sample Company” at $1.25 when the retail market is trading at more than $3. A big win for that fund but a huge risk in the eyes of retail traders.
When it comes to investing in penny stocks, read the filings to see how the companies are raising money. Factor that into your risk/reward scenario.
How To Invest In Penny Stocks #3: Consider the Industry
As I said above, not all penny stocks are cracked up to be investments and that’s ok. however, if you’re planning to invest, you should also consider the industry. Many times we’ll see companies that are part of very novel industries fail because they are so “fringe” or far away from the mainstream. This could also become a high point for investing as it presents a company blazing a trail. In this case, you’ll want to make sure that the company is well-suited for growth.
Pay attention to things like management’s discussion on the future of the company. Listen in on corporate conference calls, and pick up on any red flags that could be presented. You’ll also want to make sure that specific company is well-capitalized to keep the lights on. Start-ups can be expensive especially when they’re creating a brand new product or service. Earlier this year was a prime example of following trends and identifying industries that had some longevity thanks to COVID-19.
Many of the penny stock success stories came from companies who truly dug their heels into biotech and even technology to build a business around unmet needs. It wasn’t just an idea for these companies. They also took to action in making things happen. All too often we see small-cap companies say they’re going to do something great. But in the end, that company turns out to be just a share selling machine. In doing your DD ( due diligence), turn over every rock and look into every detail you can in order to find a sound company.
How To Invest In Penny Stocks #4: Keep An Eye On Your Investment
Obviously, your goal of investing in penny stocks is to not have to look at it every hour of the day. But we’re talking about penny stocks, here and anything truly can happen. Just because your plan is to invest, it doesn’t mean you should avoid selling when you’re in profit. One of the worst things to do is turn a winning trade into a loser because you don’t want to sell.
This year, we’ve witnessed some of the companies with what many consider great potential turn into losers. Whether it was a random insider selling or, in the case of biotech penny stocks, a bad data readout from a phase trial, even the strongest trend can change overnight. So if you’re investing in penny stocks, it doesn’t hurt to take a look at your investment on a daily time frame. Maybe not hour by hour but since things can change in a day’s notice, you still should keep an eye on your investment.
How To Invest In Penny Stocks #5: Scaling Your Position
In addition to #4, this point continues to support the idea that taking profit is never a bad idea. When investing in penny stocks, you might be better suited to scale into and out of the investment. This not only ensures that you take some profit and, at the least, cover your initial cost basis. It also allows you to eventually play with house money. Some traders will say “hold a core, trade a core.”
In this instance, I think an example might be better suited. Let’s say you’ve got a $2 penny stock you see potential in. All of the other boxes on the “buy” side of the list are checked off. Now you’re ready to buy. Instead of going “all in” at one price, you might better position yourself for the long-term by mapping out your trade. Investing a portion of the total amount you want to hold, at first, allows you to test the waters. As the stock continues higher and confirms your thesis, you might add to your position at higher prices.
Since you’ve already built a base at lower levels, your cost basis will automatically be lower than the current retail price. With the stock continuing its rise, some traders will take a small profit to cover their initial outlay of capital or partial outlay of capital. Then if the same penny stock continues rising, they might add more to their position, scaling into and out of the investment while benefiting from the rise in price. At the end of the day, you’re here to make money with penny stocks, not to hold a bag. So if there’s profit to take, no one ever went broke by taking some. At the end of the day, investing in penny stocks is higher risk, in most cases, compared to trading penny stocks so take everything one step at a time.
Originally published at https://pennystocks.com on October 4, 2020.