How Do You Know If Penny Stocks Are A Good Investment?

Time and time again, penny stocks will attract countless investors. Whether it’s for quick profits or a shot at a big return, people will look to make money with penny stocks. But to do so, it isn’t as easy as hitting the “buy” button on your penny stock trading app. Sure, you might get lucky here and there, but in the long run, luck plays a small role.

To understand penny stocks, you need first to understand investing. All investments carry risk. Some risks are higher than others, especially when considering the investment type. When you look at any list of penny stocks, you are looking at mostly start-up phase companies.

best penny stocks to buy right now

These companies have fewer assets, higher liabilities, and may have already raised expensive money. What I mean by this is that companies raise funds with stock and sometimes the price that they raise funds at is much lower than the current market price.

Penny Stocks, Charts & Technical Indicators

Understanding how to read “candlestick charts,” learning certain indicator types, and the like will help you in the long run. This is especially true if you’re style is along the line of trading penny stocks versus investing in them.

Even if you’ve never used technical indicators, learning the basics is relatively easier than you think. Things like support and resistance, trend lines, and volume are simpler tools to use. These can help cut through the noise when stocks are flying high.

For instance, if you see some of the biotech penny stocks rallying thanks to vaccine news, knowing where historic levels of support and resistance can help set your profit targets. So many times, traders will “YOLO” a trade, letting fate direct someone’s profit goals. But without proper targets set, you stand to lose more than you gain in the long run. So it’s very important to learn how to trade penny stocks from the start.

[Read More] How To Buy Penny Stocks On Robinhood

A lot of what I’m referring to has to do with the chatter you’ll likely read online. If you know where historical resistance levels are, you can set proper profit targets and score big on momentum runs. Meanwhile, novice traders will simply “hope” the stock goes higher. Learning basic technical analysis is a huge asset when it comes to trading.

Know The Basics Of Penny Stocks & How They’re Funded

As with all things, loans come at a price. In the world of cheap stocks, they usually equate to more stock and lower prices. So there will likely be growing pains for a lot of these smaller companies. Regardless, it’s important to understand that not all penny stocks are hopeless just because of how they raise money. Management is key.

Given the state of certain industries, “expensive money” doesn’t always mean death spirals for a penny stock. It comes down to how the companies manage their lenders and what their use of proceeds will be. Even if the money raised is “expensive,” a good management team will have backstops in place to protect its investors and purpose-driven plans earmarked for growth initiatives.

So a keen understanding of how to read basic financial statements is also good if you’re just getting started with penny stocks. Know how to compare assets, liabilities, revenue, and expenses. Also, be able to understand certain filing types. If there’s a company that releases an 8-K, for example, what does that mean? If you understand filings, you’ll know that there was a material event.

The same goes for identifying insider trading. How do you know if the CEO of a company just bought stock? Since insider buying is seen as a bullish stance, you’ll want to know how to identify that event. Most companies won’t release press saying that their CEO just picked up shares. But they will file a Form 4, for example, showing the purchase price and amount of stock bought. In many instances, most traders won’t look at these details until the day or days after the filing was made. Being able to know this in real-time can set you apart from the “average Joe” trader.

Penny Stock News & How To Understand It

Other things like penny stock news is important to understand. This is not only from a “hype” perspective but from a fundamental perspective as well. Let’s say a biotechnology penny stock comes out with positive trial data. If the market starts taking off, you would think, “I have to buy.”

But the experienced investor would likely wait, read the data, observe the market, and then make a decision based on their own findings. Simply jumping in because a stock is trending doesn’t make it a good idea.

penny stocks chart

If those data were positive but later in the announcement, management cited forward-looking issues, you’ve got trouble. The gut instinct for many on positive data is to buy penny stocks. But after the initial surge, further info like issues in the future could be a “gut check.” The result could easily be a huge vacuum, and the stock price plummets. Novice traders get caught holding a bag, the quick flippers might make a small profit, and the experienced traders are still simply standing on the sidelines.

If you can’t fully grasp what certain penny stock news means, it may be best to sit out instead of taking a chance on something you don’t fully understand. Likewise, let’s say there are negative data right off the bat. But later on in the news, management cites new trial data from an ancillary test that is positive.

Gut instinct traders may immediately sell. But as the news is digested, the stock price can abruptly reverse for the better. Early traders likely take a loss, novice traders may get “stopped out,” but experienced traders were sitting on the sidelines and waited to cue a bottom and take advantage of the low price before the penny stock bounced.

Are Penny Stocks A Good Investment?

At the end of the day, the answer to this question is up to you. You need to fully understand the risks involved in trading penny stocks and if you’re willing to take on those risks. Since these stocks can be so volatile, it isn’t a spectator’s sport.

But you can do a few things to ease into it. One of those things is to start by paper trading penny stocks. This involves an investor using “fake money” to sell or buy penny stocks. Though you won’t make money if you trade correctly, you won’t lose money either if the stock drops.

Another thing to consider is how much can you afford to lose? All too often, new traders go into the penny stock market with visions of grandeur. They quickly realize that cheap stocks aren’t for the faint of heart. Like anything worthwhile, fully understanding the basics is key, and education comes first.

If you’re looking for more on penny stocks, check out some of our penny stock basics articles and make sure you subscribe to receive daily email & text message updates.

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