It is often a difficult proposition for any investor to identify and buy penny stocks that offer the prospects of good returns. Often you cannot use conventional methods of identifying promising stocks because there is little information that is available and there are very few analysts who bother to follow these stocks. Despite this, penny stock investment should form a part of your overall investment portfolio because of the potential to earn higher returns in a short period of time.
However, it is easy to make mistakes and wipe out your invested capital. This means that you have to learn how to control your downside risk while still preserving the upside of capital appreciation. This is possible if you can follow some basic and common sense rules as part of your penny stock trading strategy.
The first thing is to avoid stocks that are trading on OTC markets or on the pink sheets. Stocks in these markets have few or no minimum requirements to meet for listing such as the production of regular financial statements. As a result, you are going to find it difficult to buy stocks that conform to your minimum standard of risk tolerance. You can find penny stocks that trade on reputable exchanges such as NASDAQ and the NYSE which you can be sure we'll meet some fairly stringent listing requirements.
Because you should be investing money that you can afford to lose without hurting you financially, don't expect any returns by way of dividends. It is important to remember that among the many scams that are associated with penny stocks, one involves a manipulation of mathematics with regard to dividends. Often, some kind of one-time payment is made which is annualized in order to make the stock look more attractive. Dividends should not be the basis for your investment even though it is nice to receive them as an extra.
As far as possible, base your research and analysis on hard numbers relating to earnings and whatever input from analysts is available. It is easy to create a buzz on the Internet about the next new biotech stock which is a cure for cancer or a high technology stock that promises to change the world. But you are never going to make a profit from a penny stock unless the business itself is profitable. Focusing on earnings and profitability would help you to avoid becoming a victim of hype. This is why any hard information that you can gather becomes that much more valuable.
Always make use of limit orders in the trading of cheap penny stocks. Market orders are dangerous because prices of these stocks can rise dramatically in the course of a single trading day or even a few hours. Never trade outside trading hours and chose a reasonable entry price say $.15 more than the previous day's closing. This will prevent you from overpaying for a particular stock. Similarly, when you are exiting the stock, chose a selling price which you are comfortable with. If that price is not touched on that particular trading day, carry forward your order to the next trading day.