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You’ve heard the advice a million times: Trading is a serious and tough game with strict rules – once you fall back and you are lost. In order to survive and eventually to achieve the ultimate goal – making a profit, you should learn from the best and follow some basic rules and guidelines. Today's article is a short guide for beginners who want to trade penny stocks.
What are penny stocks and why it's a risky game?
Penny stocks are relatively cheap stocks (according to the SEC, “less than $5 per share”) of companies with a small market capitalization. This is what makes them attractive, however, at the same time this is what makes them risky.
Not everyone can buy shares belonging to Apple or Amazon (currently Amazon's share is worth $970). With a small amount of money, you can purchase a large number of shares, which might bring a nice basket of money to the table.
Let's say you buy 10,000 shares each worth $0.5 which makes $5000 initial investment. Due to the company's small size, the potential for growth is basically unlimited. Assuming a couple of days later this same share is priced $1 and you sell your shares, it makes $5000 profit – the amount you have invested.
Unfortunately, it's not only flowers, but there are also thorns you must carefully avoid.
Trading with penny stocks, owing to their high volatility and liquidity, is a place where scammers and manipulators thrive. Being a rookie with a burning desire to make his first million is the easiest way to fall into a trap. This is another reason why you should be careful down the road. The journey begins!
Education Is A Powerful Weapon
“Education is the most powerful weapon which you can use to change the world.”
It's not necessary to change the world, but if you want to be a successful trader (no matter what kinds of thing you hope to invest in), you have to be knowledgeable, well-informed and skillful. Educating yourself before you start is crucial, investing in education during the whole process is compulsory.
When learning about trading, you have to be able to identify credible sources. One word on Google and you might end up with thousands and even millions of relevant results.
Do you really think everything on the net is great? Do you believe that every guy trying to sell you something is a saint trying to atone for his sins? The answer is no. How can you find the best place to be educated?
Why Financial Education Is Important
Work with a “personal” online teacher, who can show you the intricacies of the business in trading penny stocks.
Well, work with people who can actually prove what they claim. For example, the profits they have made – you can ask for some records of his trades and tax statements. Do not expect every trader to embrace you like a mother her long-lost son.
For sure, most of them won't have this proof because they are just trying to sell you something; they do not want to help you educate yourself and become an expert in the field. As already mentioned, this is a place where scammers prosper. In addition, check our article reviewing the great online gaming sites to learn stock market strategies.
Try to keep your own trading journal. This is a great and very practical way of keeping an eye on everything you have done and assessing your own performance. Here you can find a free trading journal
Liquidity Is Important
If you have read some of our previous articles, you might have noticed how important when trading in stocks is liquidity – the ability of an asset to be easily bought and sold. You have no idea how to compute the liquidity of a company? Easy tip: multiply the number of shares by their price and the result will be indicative of the amount of money flowing through the company.
The volume of a particular stock constitutes a part of its liquidity. Try to invest only in penny stocks that trade 100,000 shares a day.
If you trade just a few hundreds of a penny stock, it's much easier to manipulate the price because there aren't many sellers. Moreover, when it comes to selling, it will also be a challenge because there aren't many buyers. For sure, not being able to get rid of a position is not a great start of the day and your career.
Modest Profit Expectations
On account of their small size and market cap, indeed, penny stocks have huge growth potential. It's not impossible for stock to grow from $0.5 to $1 or even more in just a single day. Which automatically means that your trades can be highly lucrative.
Don't forget, this is possible, but does not happen every day and with every equity. So, stay relatively small; try to win less than 1$ per share. Don't chase the big dollar, this will help you stay in the game rather than chasing millions and being thrown away at an earlier stage. Another great tip is to trade up to 10% of the daily volume of a stock. This will give you the chance to quickly leave “the building” in case of emergency.
Support And Resistance
If you want to become a good trader, definitely you have to acquaint yourself with two primary methods using to analyze an investment – fundamental and technical analysis. We have to agree that technical analysis is for people who have serious background and knowledge. But even as a novice you have to be aware of two major things part of the technical analysis: support and resistance lines.
A support level is the lowest point in the charts under which, after falling down for some time, prices don't usually go. When reached, usually prices rebound and recover.
On the other hand, we have the highest point which usually stock prices reach and start falling down. It's called resistance level.
What can you do?
No extreme and impossible to decipher calculations, just look at a 6-month chart of a specific stock and its price movements. Draw two lines – the first one below the lowest point at which prices start climbing back and one above the highest point at which prices begin to fall. These two lines can indicate as to when you should buy stocks and when you should sell them.
Anytime, always. Risk evaluation is an inseparable part of trading. If you don't have your risk management, do not enter this ocean of stocks.
Belonging to small, some of them new companies which are extremely volatile makes investing in penny stock a perilous venture. It's true that their shares can soar and on the next day fall down like a diving bird.
In addition, most of these companies cannot comply with the criteria and requirements set by the SEC (US Securities and Exchange Commission) which is the reason why they are traded on the so-called pin sheets. Having said that, logically, this opens room for many speculations and manipulation of stocks.
According to the SEC, “investors in penny stocks should be prepared for the possibility that they may lose their whole investment (or an amount in excess of their investment if they purchased penny stocks on margin).” Keep that in mind when preparing your risk strategy.
Trading penny stocks could be a profitable move and make you rich in a short period of time. However, it can also make you poorer than you used to be because you can lose more money than you have invested initially.
This is a serious game for well-prepared and tempered players. Certainly, reading our guide will not transform you into a superhero, but surely it will help you to start and position yourself. The rest is practice and perseverance.