Additionally, penny stocks are fairly easy to buy. Shares are readily available to the public and an investor can open an electronic trading account to trade penny stocks, usually with a minimum of $500 – $1,000 to open an account.

The largest advantage of penny stocks is the potential they provide for high returns on investment. It is much more of a possibility that a penny stock can provide exponential gains, doubling, tripling or more in a short period of time, than an average or blue chip stock.
It would not be prudent to write an article highlighting the advantages of penny stocks without also highlighting the high risk that goes along with them. Penny stocks can certainly provide a large return, however they pose a large amount of risk because of the usual lack of publicly available financial information. Because of this lack of information, it is difficult or impossible for many penny stocks to trade based on fundamental valuation so it is hard to predict their behavior using the same methodology as you would when evaluating a blue chip stock.

For this reason, it is important to perform as much due diligence and research as possible before investing in a penny stock in order to find out as much information as possible regarding new developments, future plans, milestones reached, etc. Additionally, it is very important to examine a stock’s past performance and how it reacts to the release of news as well as its liquidity.
There are several penny stock newsletters and websites that one can go to in order to see which stocks are being talked about the most and perform research on individual stocks. Additionally, Yahoo Finance! is probably the most followed finance site for individual penny stocks. Quotemedia.com is an especially helpful site to look at historical price and volume.

In addition to liquidity and reaction to news as well as other factors, which penny stocks are being talked about at a given time are a great place to start when considering trading or investing in penny stocks. As we stated earlier, because of the lack of public information about penny stocks, publicity and buzz are very important factors to use when evaluating a penny stock.

In summary, the largest advantage of trading penny stocks are the ability to invest a small amount of capital while having the potential for a stock to experience very large short term gains. While the capital risk of trading penny stocks can be low because of the low price of stocks, the risk factors are very high which is why high returns are possible. Also, realize that the most important factor when selecting a penny stock to trade or invest in, is research and due diligence. One must realize that publicity and buzz can many times be the most important factor when timing the trade of a penny stock.

It is critical to try to keep these emotions in check and maintain an even keel where you make a conscious effort to acknowledge, fight and overcome these emotions in order to make the best investment decisions possible. There are time-tested processes that can be used to remove the effects of emotions from your stock trading.

Perform Due Diligence Before Entering a Position
One of the most common of these processes it for an investor to wait before they make a final decision to purchase. An investor may see a stock that they like and rush into making a purchase with the belief that they have to buy or sell a stock that day. It is recommended that an investor always track the performance of a stock for a particular period of time before deciding to make an investment or a trade. This is a simple yet effective rule that can eliminate one of the most common trading mistakes driven by emotion.

Trade Automation
The easiest and most highly recommended method of eliminating your emotions from trading is to automate your trading. This is very easily done if you have an electronic brokerage account such as TD Ameritrade, ETrade or Scottrade. If you have a traditional broker, you can also ask them to automate your trades for you. You can utilize various order types such as limit orders and stop-limit orders in order to ensure that you liquidate or fill your position when it is most prudent to do so as decided at the beginning of your investment process, not during it, while your emotions will most likely run high.

Remember the market will take its course regardless of your emotions so you must be sure to automate your trades in order to maximize profits and minimize losses from a logical perspective without letting emotion cloud your judgement.

The Biggest Mistake – Not Letting Go of a Losing Stock or Position
In addition to rushing into making an investment decision or entering a trade, the other most common mistake that investors make is not knowing when to exit a position and cut their losses if the market moves away from them. Many traders become emotionally attached to a stock, whether it be positive or negative. If a stock moves against them, then they begin to get angry and may become resentful at that stock and hold onto a position until it moves back in their favor and many times it does not. Or if it does, then it moves further out of favor first, forcing an investor to cut their losses too late after already incurring a larger loss than they had to.

The Danger of Greed
It is human nature to become greedy and want more once we are presented with a situation where we have gained something. This is apparent nowhere more than when it comes to trading stocks. Many investors will see a stock make a positive move and in many cases will move away from their pre-determined exit price (if they had one) because the excitement of making a profit puts greed in motion and they then do not sell a stock when their prudent side knows they should in order to lock in profits. In such cases, a stock may then go down and an investor will fall into the trap we listed above of holding onto it all the way down in hopes that it will get back to where it was when it appreciated. Emotions are human and they will no doubt exist when trading stocks. The key is to perform as much due diligence as possible in order to set an entry and exit price that will logically provide the most profit. This way, you can then automate trades to reflect your trading strategy and let the market do the rest. At this point, you must stick to your plan in order to optimize profit opportunities. Trade with your head, not your heart and you will have the best chance to succeed in trading stocks.

Lack of Operating History
Whether an investor is looking to perform fundamental analysis, technical analysis or both, effective research requires that a company have an operating history so that investors can predict future performance based on a stock’s past performance. Many penny stock or micro cap companies are either newly formed or are in poor financial condition which leaves investors without any solid history to base an investment decision upon.

Lack of Publicly Available Information
Along with a company’s operating history, the amount of accurate and publicly available financial information it provides is key to an investor being able to make an informed investment decision. Companies listed on the pink sheets are not required to file with the Securities and Exchange Commission (SEC), hence are not publicly scrutinized or regulated like stocks that trade on the the New York Stock Exchange, AMEX and the Nasdaq. Additionally, much of the financial information that is available about penny or micro cap stocks may not come from credible sources because of their lack of regulation.

No Minimum Listing Standards
Many investors view minimum listing requirements as a safety cushion or benchmark against which to measure companies. Stocks that trade on the OTCBB and pink sheets do not have to fulfill any minimum requirements to remain traded on the exchange. For this reason, many stocks that trade on the OTCBB and pink sheets are companies that previously traded on one of the major exchanges, however were not able to fulfill their listing requirements hence they moved to an over the counter exchange.

Common Misconceptions about Penny Stocks
There are two popular misconceptions about penny stocks that many investors have. These are the fact that many or all of today’s blue chip or high price stocks were once penny stocks that have appreciated and that there is a positive correlation between the number of shares a person owns of a stock and its potential returns.

Investors who hold the first misconception believe that all or most large companies were once penny stocks usually make this mistake by looking at the “adjusted stock price” of a company which takes into account all previous stock splits. This is not the case as most blue chip companies started trading at a fairly high price and continued to rise until the company saw fit to implement a stock split.
The second misconception that many investors have about penny stocks is the fact that because a stock is priced lower, it provides investors with an opportunity to own more stock than if they purchased a higher priced stock and there is more room for price appreciation and greater returns. For example, if a stock is trading at 20 cents and rises by just 10 cents, this is a 50% return which would be much more difficult and unlikely to be reached by a stock trading at say $20 which would require a $10 jump in price to provide the same return. While this is technically true, it does not take into account the main reasons we highlighted above that penny and micro cap stocks are riskier than higher priced stocks.

The fact is that a 20 cent stock has a much higher chance of not succeeding and of going down in price, perhaps to zero, which could lose an investor’s entire investment. Also, when measuring a stock’s return, an investor must take into account the dollar value invested rather than the number of shares purchased. It is the dollar value that adds or subtracts a percentage gain or loss to determine the final return of an investment.

Conclusion
There are several penny stock and micro cap companies that will be successful and can provide tremendous investment opportunities for investors with a high risk tolerance. However the key term to remember here is “high risk tolerance” because there is a much greater chance that a penny stock will not succeed than a higher priced blue chip companies for the reasons listed in this article. The key is caution and knowledge of what you are getting into when investing in penny stocks, realizing that a potential lack of liquidity, operating history, listing requirements and publicly available information make penny stocks very risky with several pitfalls to trap investors. Research, risk awareness and prudence are the keys to successful penny stock investing which does exist.

Most penny stocks trade in the over-the-counter markets such as the OTCBB or OTC Markets. Some penny stocks do trade on major exchanges such as the AMEX, NYSE or NASDAQ as well as foreign exchanges.

What is a short-term trading strategy?
A short-term trading strategy is one where you enter and exit a position within a range of time from minutes to weeks. The official definition of a “short term” trade according to the tax code is entering and exiting a position within one year. Most successful penny stock traders implement a short-term trading strategy as it is geared toward making rapid profits rather than evaluating a company’s long term potential.

What type of broker should I use?
There are two primary types of brokers, traditional brokers and online brokers.
Traditional brokers such as Edward D Jones, Merril Lynch and Ameriprise to name a few, typically recommend products or services, charge larger fees and often times do not offer online trading. Traditional brokers are usually not utilized by penny stock traders because the rapid nature of trading decisions and execution do not allow for time to get a broker on the phone. When day trading, the markets move too fast for this type of execution.

Online brokers such as ChoiceTrade, Scottrade, Etrade, Charles Schwab and others allow you to place trades yourself online through their trading platforms at very low fees. Most online brokers require a $500-$1000 deposit to open a trading account. Once an account is open, there are usually only per-trade fees and no minimum trade sizes for account owners.

What do you need to get started?
Enough money to open an account which, as we stated above, is usually between $500 and $1,000. You must also have a high risk tolerance as penny stocks are riskier than higher priced securities which is why their rewards can be much greater. The next step is to perform due diligence on penny stock trading and the securities you are seeking to trade. At this point you would open an online trading account and begin trading.

Why are penny stock prices so volatile?
Penny stocks trade differently than higher priced securities because in most cases they are trading without sufficient publicly available financials, hence do not trade based on fundamental valuations and have much less liquidity. Because of this, penny stocks are easily affected by the herd mentality, which leads to swarms of investors either rushing to get in or out of a stock, particularly because of liquidity concerns. This can cause large and erratic price swings in penny stocks which must be successfully navigated in order for a trader to earn profits.

How to get started?
Before you begin trading, the most important thing you can do is perform your due diligence on the penny stock markets and trading in them as well as specifically about any security you are considering trading. The worst thing you can do is to rush into a position without having done your own research so that you are comfortable with the risk-reward relationship of a stock.

It is very important to check that a company you invest has increasing revenues or the prospect of generating revenues in the near future and ideally they should be profitable or near profitability. While its not unusual to see a start up company run at a loss, its important to look at why they are losing money. Is it manageable? Will they have to seek further financing (resulting in dilution of your shares) or will they have to seek a joint partnership that favors the other company?

If a company knows how to make a profit, the company can use that money to grow their business, which increases shareholder value. You have to do some research to find these companies, but when you do, you lower the risk of a loss of your capital, and increase the odds of a much higher return
You should also figure out who owns the majority of the company’s shares. If insiders own most of a company’s shares or they sell a large amount of their shares, then you must pay attention to the motivation of management. The possibility of success can be increased if you see that management owns a large amount of shares, however if you notice that management is selling these shares, then this can be a negative signal.

Trading volume is another important factor that you need to observe with penny stocks. In order to profit from penny stocks, you must look for stocks that have liquidity therefore you want to find stocks that consistently trade high volumes. For this reason, it is not necessarily a good idea to use average volume as a gauge but you should check a stock’s daily and weekly volume. Consistent volume is critical because if no there is no volume in a stock that you own, this can create selling pressure, forcing you to sell at a much lower rate than you would like, not to mention the fact that you may not be able to sell all or any of your position in extreme cases.

It is also important for you to create a plan of entry and exit and make sure you stick to your plan. Penny stocks are very volatile, moving both upward and downward at a fast rate. It is not uncommon for penny stocks that have volume to see swings in either direction of 20 percent or much more on a daily basis. Because of this, you must make sure to always use a stop-loss order to limit your losses on the downside, however also set limits where you sell and take profits in the event that the stock gains the percentage that you initially decided you would be happy with. Many traders let their emotions get the best of them and continue to ride a stock, hoping for higher profits, only to see it crash down and lose profits or sometimes go from a significant profit to a loss on the stock. The proper use of stop-limit orders helps you avoid these scenarios and assures that you can secure your gains and limit your losses, helping your portfolio to steadily grow.

To give you a perspective of what happened at the low point of the previous recession the world went from a total market capitalization of $57.5 trillion in Spring 2008 down to $40 trillion by the Fall of 2008. Needless to say this was not good news to take home to your boss if you were in a position of financial authority such as the Federal Reserve, Bank of England or the head of the Central Bank in any major European country. A curious thing was happening during all the financial upheavals during the fall of 2008 through to the spring of 2009. Small-cap stocks kept chugging along and the traders continued to buy and sell.

Now the word capitalization is really a measure of how we classify the size of the company. In the past there were three specific groups; small-cap, mid and large-cap stocks. Over time, after making adjustments for inflation and the penchant for companies to swallow each other and grow bigger, the definitions had to grow as well. Now we have mega cap, big cap, mid cap, small cap, micro cap and nano cap companies. The differentiations start in the billions with mega cap companies ranging in the 200 billion or more in total value. Big caps now go to 10 billion or greater, mid caps are $2 billion to $10 billion, small caps are $300 million to $2 billion, micro caps are $50 million to $300 million and nano caps are under $50 million.

The point I’m making is that the world did not end in 2008. Small-cap stocks and micro cap stocks were still being traded heavily even as companies like Goldman Sachs, AIG, Wachovia, Lehman Bros. and other giants buckled under their own weight. Nimble small-cap stocks were still moving during this period in a variety of markets. There is no doubt that they were affected by the global financial meltdown but life went on for these small companies.

Historically small cap stocks have had a bad reputation because of their ability to roll in and around FTC regulations. For decades the stock analysts never even covered companies with less than $300 million. The term penny stocks usually never made it on the air when an analyst spoke about the rapid fluctuation in trading throughout the day. These companies were seen as risky and frequently lacking any credibility or quality for investors. Consider the fact that companies like WorldCom and Enron were large-cap stocks yet their owners perpetrated massive fraud against shareholders and the public. When it comes to dishonest activities size may not be a real issue.

Consider that small-cap stocks may not be valued at several hundred dollars per share but on the other hand you can afford to purchase multiple shares of penny stock companies without breaking your piggy bank. The truth is, small-cap stocks have historically outperformed the overall market for decades. One reason for this trend is the sheer momentum that occurs when a company goes from $0.008 a share to $16 a share during a 52 week period. Large-cap stocks cannot move in that wide a margin because it is already near the top of its valuation.

Another benefit of looking closely at small-cap stocks is the sheer volume of companies within that range. Anyone who takes the time to investigate small-cap and micro cap stocks may end up finding a nugget or two that will eventually become another Microsoft, Apple Computers or Wal-Mart. Remember that these companies were once small-cap stocks at one point as well. Although hindsight is 2020, imagine owning 5000 shares of Home Depot stocks back in the days when they were struggling to meet their capitalization requirements to remain on the exchange.

If you as an individual investor want to take control of your portfolio, think about adding small-cap stocks to diversify your holdings. As a rule, giant mutual funds seldom look at small-cap stocks as part of their portfolio which means you have an advantage to get in and buy stocks cheap. That means you can explore an untapped market as an investor. If your strategy is to buy and hold, you only need one or two gems in your portfolio to mature in a few years into a mid cap or large cap stock. If you are a day trader there is nothing sweeter than watching the ticker move as volatility takes your stock price to 200% or 300%.

Many day traders love penny stocks because they do have the potential to profit greatly from momentum in either direction. There are traders who sell high and buy low then pocket the difference in the final transaction. This is called shorting the market. Short selling has become one of the most profitable trading techniques.

Small cap stocks have a separate universe of followers who watch patiently for the volatile swings that sometimes occur in the markets. This is the golden opportunity when a patient stock trader can walk away from a successful trade with a 100% increase. This kind of opportunity is seldom seen in large-cap stocks. Evidence of this can be appreciated in the 52-week spread in the stock charts. While a multinational corporation may see its stock move 10 or 12 points in either direction over 52-week period, it is not uncommon to realize a 300% movement in the 52 week charts of small-cap and micro cap stocks.

As with any endeavor that requires you to part with your money temporarily while someone else uses, it there is risk involved. Any money you invest in the market should be extra money, not your kid’s college fund or your retirement savings. If you are a day trader watching your stocks fluctuate wildly in a single day may take nerves of steel. In spite of all that there is merit to considering penny stocks or small-cap and micro cap stocks.

Small-cap stocks allow you to diversify your portfolio at a reasonable cost. You can help manage risk through including small-cap stocks with a proven track record. There is enormous growth potential in small-cap stocks although there is increased risk. Take the time to investigate this hidden side of the market; there might be treasures waiting for you.