Many different kinds of companies are trading as penny stocks — their share prices under $5 per share, but most trading under $1 per share. Some are bankrupt corporate shells that may someday be trading as entirely new companies. Some are young companies that have merged into those shells to trade on the public markets as an initial public offering (IPO). Some are small banks or credit unions. Some are failing companies, just limping along, and others are scams. You can find the diamonds if you have the skills to wade through the trash, but it takes extensive research and a skeptical mind-set. Penny stocks represent a great opportunity to lose all your money if you don't have the skills and market sophistication to analyze the underlying company and trade the stock like a pro.
Familiarize yourself with OTCmarkets.com, which represents the various self-regulated stock exchanges (SRO) where penny stocks trade, such as the Pink Sheets. They carry news, quarterly and annual financial reports and also indicate levels of company compliance with reporting standards, which can serve as a heads-up for company troubles.
Use an online interactive stock screener to screen for industry, market capitalization, earnings, price/earnings ratio and other important stock qualities.
Read the quarterly and annual reports of companies that you have selected from the stock screener. Apply a skeptical eye to what you read, because companies will always present their information in the best light.
Call the investor relations manager at the companies you are considering. Evaluate the information you receive, keeping in mind that investor relations can't tell you anything that is not already public information. Calling people at competing companies to ask their opinion of your selection may be more informative.
Watch the news flow and trading over time. Many small stocks go through regular stock promotion campaigns, so watch for sudden trading activity and monitor the performance of the stock after this activity has died down.
- The penny stock market is more of a trading market than an investment market. For this reason, you should learn technical analysis of stock price charts. Although technical analysis won't guarantee you profits, it will give you a fighting chance.
- Beware of email stock promotion campaigns and the pumpers and bashers that abound on the online stock trading bulletin boards. They are talking their own positions, whether they own the stock long or have sold the stock short hoping to buy it back at a lower price to cover their short sale. Do your own due diligence.