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Penny Stock Trading: A Real, No-Hype Intro to Penny Stock Trading

Updated on March 24, 2013

To succeed with penny stock trading, first int is important to exactly what a penny stock is and why it has earned its name.

Before you begin buying penny stocks it is important to know the risks involved with penny stocks and how these risks can lead to ruin if you are not responsible and wise. This is especially true if you want to engage in day trading penny stocks.

I will define for you the term penny stocks, then discuss the penny stock risks you must evade. Perhaps most importantly, I will attempt to illuminate the potential fraud schemes you certainly will face as you embark on your penny stock trading journey. And lastly, I will teach you the core strategies used by all savvy penny stock investors.

Penny Stock Trading Isn't For Cowards
Penny Stock Trading Isn't For Cowards

Penny stocks have a variety of different definitions.  The most common definition is just a stock which trades for under $5 a share.  However, many also believe it must be traded off the major exchanges on OTC (Over-the-Counter) quotation services like the OTCBB (Over-the-Counter Bulletin Board) or the Pink OTC Markets (Pink Sheets).  Some people further believe they must also be microcap stocks, which are stocks of companies with a market capitalization calculated at under 250 million dillars.

For this article, we will call a penny stock any stock which trades for under $5 a share and which is traded via OTC quotation services.

Problems With Penny Stock Trading

Before you begin penny stock trading, you must fully appreciate the risks involved. Penny stock traded on the OTCBB and Pink Sheets have three problems you should appreciate and understand before proceeding.

First, they often feature minimal public data compared to stocks on the major exchanges (like AMEX, NASDAQ or NYSE). Second, penny stocks in this range tend to feature a very low liquidity, which means they don't sell easily. This is particularly important to understand because their values change quickly, so you don't want to get stuck with stock you're desperately trying to unload. And third, people buying penny stocks or day trading penny stocks will face a particularly large frequency of securities fraud.

More Than Pennies Are At Risk When Trading Penny Stocks
More Than Pennies Are At Risk When Trading Penny Stocks

Penny Stock Trading Fraud

There are three primary penny stock frauds you need to understand, but note that these are not the only forms of penny stock fraud. If you're in the penny stock trading market, you need to exercise an extra dose of caution and skepticism.

First, be wary of the pump and dump. With the pump and dump, you will see speculative stock (stock changing values based on hype or news rather than real value) aggressively hyped and sold by a small group of investors. By manipulating public data and artificially inflating sales of the stock, they "pump" the value up temporarily. Then once it has pumped to a point where they can accrue significant profit, they dump it and its value quickly drops again. This is highly illegal and remarkably widespread on the Internet. Never take someone else's word on a stock potential: do your own thorough research.

Second, to successfully embark on penny stock trading you need to ignore any unsolicited email regarding penny stocks. A huge amount of securities fraud takes place with penny stocks and email spam. Never, ever even bother to read unsolicited email regarding penny stocks or microcap stocks.

Third you need to be very wary of hard sales on any stock. There is phenomenon known as boiler rooms in stock trading that is particularly active in day trading penny stocks. Basically, a team of salesmen has a list of known suckers or novice investors which they cold call or cold email and give a hard sale on a penny stock. Again, never ever buy penny stocks without exercising responsible due diligence.

Penny Stock Trading Strategies

Once you are sure you can steer clear of the problems and scams related to penny stocks, it is time to start considering the basic tactics involved with penny stock trading. You'll find two basic strategies in buying penny stocks, the long plays and the short plays.

When you seek a long play in penny stocks, you are seeking a company with solid fundamentals and distinctly promising future. Basically, you're looking at a company you can invest in for the long term. You can reap tremendous profits by holding on to a company stock which you bought at under $5 a share that over years grows to the dozens or even hundreds of dollars a share.

When you seek short play penny stocks, you're probably working something like day trading penny stocks. You are looking for a specific pattern of rises and falls in the stock value (called channeling), and after you have confidently established its pattern, you buy penny stocks in the valleys and sell at the peaks. This is a particularly delicate are of penny stock trading and I don't recommend doing this without some real practice with charting software and paper trading (which means trading for practice without money).

To Trade Penny Stocks Successfully, Be Cautious

Be very wary of all the hype you read around penny stock trading.  It is an investment field fraught with peril more than ripe with riches. 

I have now taught you the definition of a penny stock, the primary risks involved in trading penny stocks and the most common forms of fraud to which you will be exposed.  I also taugh you the basic techniques to consider when you research and practice penny stock trading before you actually wade into these shark-infested trading waters.

You can make money in penny stock trading but I urge you to exercise caution, skepticism and due diligence before you lose your shirt to foolishness.

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