5 Things to Know Before Investing in Penny Stocks

Penny Stock Investing

Penny stocks are some of the most enticing investments on the market. And for good reason. The penny stock market is one of the most high-potential segments of the market.

Pick right and you could own hundreds—or even thousands—of shares that experience double, triple, quadruple, or even higher returns. At the same time, penny stocks are not exactly known for their staying power and reliability.

And that’s what makes the penny stocks to watch so important. They are highly volatile stocks that could pay off big-time (if you choose the right ones).

Identifying, classifying, and ultimately investing in penny stocks takes careful attention to detail, a strong analysis of the market, and—at times—nerves of steel.

There are plenty of ways that a ticker on the penny stock market can go very right, providing lucrative results. There are also, however, potential pitfalls that investors ought to be aware of and ready to avoid.

And that brings us to five things to know before investing in penny stocks.

1. How to Find Penny Stocks

The key to finding a good penny stock is not all that different from finding any good investment opportunity: know the company.

One of the most crucial investing tips you’ll often hear is to understand the company inside and out. If you do that, you should have, at the very least, comprehensive background knowledge about that particular company.

With that information in hand, you should be able to identify what about the stock makes it a solid pick, what about the company gives it a competitive advantage, and what about the stock would make it sustainable.

By nature of it being a penny stock, you’ll often find a company that is undergoing one of several different stages that more established companies have often moved past.

For instance, a penny stock could belong to an upstart company with an experimental or new product, or perhaps a company with an innovative production method. Conversely, a penny stock could be a once-higher-valued stock that fell upon hard times but is now looking toward a resurgence.

A penny stock could also be from a company operating in an emergent industry where the market is still being established. That situation is perfect for high growth.

The point is, there’s a reason a penny stock is a penny stock, and that should not be ignored. The takeaway here is to do your research so you can have trust in your investment choice.

2. How to Invest in Penny Stocks

Like with all types of investments, the key to investing in penny stocks is timing. One of my preferred strategies is to find an emergent technology or industry and identify a strong, if undervalued, player within that sector.

In the tech world especially, there are many companies vying to bring us the next revolutionary new product or the next innovation to an existing platform or service.

Find said market—and then identify a capable player operating within that market—and you may discover a winning penny stock. It isn’t as difficult as you might think—if you follow the news closely enough.

The best penny stocks to watch are those that are about to be swept up in a torrent of goodwill and hype due to a particular industry’s growth. While you don’t want to be caught by a company that’s all hype, allowing a bit of excitement to push stock prices higher never hurt anyone (just look at Apple Inc. (NASDAQ:AAPL) before every “iPhone” launch).

3. How Risky Penny Stocks Are

Due to their relatively volatile nature, penny stocks can be prey to day traders and short-sellers, and—in general—run the risk of collapsing due to their low prices, low market caps, and lack of prolonged stability.

As I’ve mentioned before, there’s a reason these companies are on the penny stock market. Knowing that reason and being comfortable with it means you can, with confidence, put some money into that bargain ticker.

At the same time, remember why you’re investing in penny stocks. It’s not for a dividend or because you expect modest growth over a 20-year span. If you’re in the penny stock market, it’s because you’re looking for something more along the lines of a gamble than a slow-and-steady approach.

It’s a risk/reward dynamic that’s not for everyone, but it’s ultimately one of the best ways to get paid fast from playing the stock market.

4. How Penny Stocks Are Traded

Penny stocks can be traded on exchanges like the NYSE and the Nasdaq, but they’re also often traded over the counter through the Over-The-Counter Bulletin Board (OTCBB) and/or through the use of pink sheets.

It’s worth mentioning again that penny stocks are often the targets of day traders and other investors looking to make a quick buck, which can increase volatility.

Penny stocks are not always buy-and-sell investments, but there are usually more dramatic swings in a penny stock’s price than with other stocks. That’s especially true in the early days after a large surge, when trading will increase and so too will the unpredictability.

5. Where to Invest in Penny Stocks

The way I see it, there are three sectors in particular that have drawn my interest in terms of where to find the best penny stocks to watch. Before we get to those three sectors, however, it’s worth talking about an honorable mention.

I am a strong proponent of the artificial intelligence (AI) market, and I believe that companies that harness this technology and use it to its fullest capabilities will be among the tech titans of the future.

The only issue is that a lot of big players, with vast amounts of resources, are competing in this space. They often buy up smaller competitors, especially when it appears that a smaller competitor is nearing a breakthrough or is developing an innovative technology.

Having said that, AI penny stocks could be some of the more valuable stocks on the market, due to the industry’s potential. Of course, as mentioned earlier, you’ll want to check out each company individually before getting too hot on investing in AI stocks. The first barrier is finding those companies.

That said, let’s get to the three sectors I see poised for growth and which could have plenty of penny stocks to choose from. They are:

1. Augmented reality (AR) penny stocks
2. Lithium mining penny stocks
3. Marijuana penny stocks

AR has been lauded by tech luminaries like Apple CEO Tim Cook, and its potential was put on full display with the roaring (if short-lived) success of the video game Pokémon GO.

Lithium mining is projected to run into two different tailwinds. The first is the increasing demand for lithium as the material becomes integral to powering everything from zero-emission cars to our homes. The second is that lithium has been jumping in price as a result of its high demand.

Legal marijuana as an industry already has some of the hottest penny stocks to watch. The sector’s ability to transform stocks worth less than a dollar into ones with exponential gains has been demonstrated several times.

These three industries might be some of the better ones to watch, especially where penny stocks are concerned.

The penny stock market is often a large beneficiary of an industry-wide trend or push, and the aforementioned three sectors all seem to be on the rise, both in the near and long terms.

Should You Invest in Penny Stocks?

Admittedly, penny stocks are certainly not for everyone.

The penny stock market can be daunting. It’s full of great ways to make some big returns, but also a lot of duds. That’s not necessarily all that different from the stock market at large, but it’s far more prevalent with penny stocks.

That’s why finding good penny stocks to watch, biding your time, and making your play at the right time is key to seeing favorable results.