If you are a financial news reader, chances are high that you have encountered stories on penny stocks. You have probably read stories on ‘strategists’ who offer stock picks or who offer trading signals for a fee. Probably, you have read stories of people who have left their high paying jobs to become full-time traders. Perhaps, you have read of people who have lost a fortune because of penny stocks. These stories are always there because of the interesting nature of penny stocks. They trade for less than $5 and therefore anyone can afford to buy them. A slight movement in the share price can lead to very attractive returns.
What is a penny stock?
This is a very common question among new traders. A penny stock can be defined in different ways. The SEC approved definition is a company whose share price is less than $5. However, this definition has its limitation. This is because not all companies trading for less than $5 are penny stocks. For instance, SiriusXM current share price is $4.25. However, this is a billion-dollar company and the largest in terms of satellite radio. There are other highly valuable companies that trade under $5. Most of the penny stocks are traded in the over-the-counter market.
The share price of penny stocks is usually very attractive to many traders. They assume that the chances of a company moving from $0.5 to $1 are very high. In such a situation, a trader would have returned 50% of his investment. However, this is not always the case. These companies are highly volatile because of their situations. Most of them are highly in debt. Others are usually briefcase companies with no real products or services.
How to Find Good Stocks to buy
As a penny stock trader, you can decide to focus on the companies listed in the OTC market or those in the large exchanges like NYSE and NASDAQ. Ideally, the companies listed in the large exchanges are usually better for long-term traders. This is because it is easy to understand these companies. Their information is readily available in their disclosures. In fact, the managers are required to issue regular statements such as insider transactions. Therefore, you can easily predict the movements of these companies.
On the other hand, companies in the OTC market are a bit different. These companies are usually small. They have a market capitalization of less than $50 million. They are not mandated to release disclosures. In some cases, the companies have less than 5 employees.
Qualities of Good Stock Picks
The small cap companies you should decide to use should have a number of qualities. For instance, they should be real companies selling real goods and services. They should also have good managers who are focused on achieving success. The companies should have a good reputation of performance. They should also be valued correctly. If you are a long-term trader, your goal is to buy a small cap stock that will soon break-out and realize huge potential gains. For instance, if you find a pharmaceutical company that trades for a dollar. If the company comes up with a drug that is accepted by the Food and Drug Administration (FDA), chances are that the share price will go up. The company can even be a target for acquisition. Take a look at the chart below. Investors who bought the company when it went public have made a lot of money.