Finding a good penny stock to buy can be much like going to a used car lot looking for a high quality vehicle. While it is possible, much caution is used before a purchase. Listed below are some steps to take before buying low priced shares.
Research the Penny Stock Before Buying
While this may seem like a 'no-brainer,' it is amazing how many people want to make a quick dollar and will completely forgo due diligence.
When trading penny shares on the Pink Sheets exchange, little fundamental information may be available. Some basic data might be present and this should be carefully scrutinized. For most investors, they will simply stay away from these highly volatile shares shrouded in mystery by an exchange that his little transparency.
OTTCC or Over The Counter Bulletin Boards have more SEC requirements than the Pink Sheets. These should be carefully examined for debt, cash flow, and earnings. These reports create more transparency and responsibility to the shareholder. Many high risk investors feel comfortable at this trading exchange.
Bigger exchanges with penny stocks such as the TSX (Canadian exchange), Nasdaq, and the AMEX, provide increasing, but still varying degrees, of accountability. If an investor is willing to accept the higher risk of buying penny stocks but still wants a reputable exchange, he will likely choose one of the above if in North America.
Penny Shares and Technical Analysis
Stock market charting can be a nightmare with penny stocks. The reason is that the majority of penny stocks are lightly traded and therefore illiquid. A chart with price and volume might have lines and indicators all over the place since some days have little or no trading, and high volume days have extreme price moves.
That is not to say one should not use charts, because they absolutely should. The two key factors that should be analyzed are:
- Volume accumulation or distribution
- Trend of price movement
Instead of looking at individual trades throughout the day, an penny stock trader should try to time his buys with a large accumulation of shares. Volume tools such as the Money Flow Index, Accumulation and Distribution indicator, as well as On Balance Volume all provide excellent methods to track volume.
Instead of trying to find chart patterns in prices between individual days, the investor should look at a multi-month trend to have a more accurate guess where this stock is heading long-term. Short term analysis may not be helpful especially since stocks with low liquidity will give a poor purchase price since the act of buying may drive shares up dramatically.
Another reason to shy away from short-term analysis is that penny stocks are the easiest to manipulate by people with evil intent. Hiding a long-term movement is much more difficult.
Buying the Right Penny Stock
Low priced shares can lure investors with massive price movements, but each person should protect himself by performing due diligence in this market. Fundamental research and examining SEC filings is one way to reduce the risk somewhat. Another is by using long range technical analysis. This article provides some reasons to shun this investment vehicle.
Before looking to where to find penny stocks such as the TSX or on a list, the investor should review risk management techniques.
Sources
Nicole Jacoby, "Get Wise to Penny Stocks", 27 July 1999, CNN Money.
Rex Moore, “Be a Penny Stock Millionaire!”, 10 Nov 2009, Motley Fool.
