What they are doing may be illegal but this is no consolation if they have already pocketed your money. You must also remember that regulators like the SEC do not have the resources or the manpower to chase thousands of small time crooks. This is why you should always resist temptation no matter how attractive it may seem. The best bargains often turns out to be a basket of snakes.

Never follow penny stock tips or reports that are given out for free. A little thought will tell you that these folks are not philanthropists who are doing this out of the goodness of their heart. They have to be making money from somewhere and you can bet that this is going to be at your expense. Very often, they get paid by unscrupulous promoters or operators to hype particular stocks. This is the classic “pump and dump” where they have already accumulated large quantities of a particular penny stock dirt cheap and are looking for suckers on whom the stock can be dumped.

Very often these tipsters or websites will require you to register and provide your e-mail in return for a free newsletter or free pick service. You should never ever give out your e-mail under these circumstances because there’s a good chance that these people are going to sell your e-mail address to third parties for a fee. This leaves you vulnerable to spam and manipulation as they persuade you to buy some worthless penny stock. Once again, they will try and tempt you to become greedy, a temptation that you must always avoid.

Another don’t is to make a conscious decision not to trade on the pink sheets. Because there are no regulatory nor disclosure requirements, it is fair to say that by and large that only the companies who are trying to dodge these requirements [making them exceedingly high risk investment] will choose to list here. There is also no commitment to transparency or keeping investors adequately informed. There are reasonable quality penny stocks to be found on the NYSE or the AMEX who are regulated and governed by the discipline of these exchanges.

Penny stock trading is high risk and dangerous enough on its own and you should not complicate matters further by taking on risks that you do not have to take. There are plenty of scams in these markets and if you choose to swim with the sharks, prepare to end up dead. To be sure, there is money to be made on trading penny stocks but only if you trade with the utmost discipline and discrimination. There is absolutely no substitute for hard homework and extensive due diligence.

The next thing is to learn some concepts that will teach you what not to do. Though used by many inexperienced investors, you should avoid averaging down at all costs. Novices tend to buy stock and then buy more as the price drops. To be sure, this brings down the average cost of acquisition but have you ever stopped to think that this may amount to throwing good money after bad. The approach may work with high-quality stock but it’s extremely speculative when it comes to high risk investment To give you a concrete example, you buy 1000 shares at a price of two dollars and a further 1000 shares as the price drops to one dollar. You now have 2000 shares at a total investment of $3000 which gives you an average cost of $1.50. You are already looking at a loss of $1000 at current market value of one dollar per share.

There are several problems with this approach. You may have made a mistake in your original choice and are now compounding that with a further investment. The second problem is that the share is trending downwards and something dramatic has to happen for the price to bounce back even to just cover your total investment. Realistically, this is not going to happen and you are merely pumping in more money into a ship that is already sinking. Moreover, as the example shows, the maxim of prudent investing is to minimize losses and preserve trading capital and averaging down does precisely the opposite.

The other thing that you should always keep in mind in trading penny stocks is to use your trading capital as efficiently as possible. You may not be fully aware of the reality of trading mathematics. If you own a stock that has dropped 50% in value, you need to see a recovery of 100% in value just to break even. If the drop is 75%, you need a recovery of 300% just to get back to your starting point. Naturally, the best way to avoid this situation is not to get into it in the first place. We all make mistakes and make losses some of the time. The only way to minimize your losses is to bite the bullet and get out of the position otherwise you may well be staring at a much larger loss.

The first mistake has to do with selling. Generally speaking your profits are determined by the price at which you buy and if you buy at a good price, you have a good chance of making a handsome profit. Nevertheless, you still have to sell in order to put the money in your pocket and this is where mistakes are commonly made. For instance, beginners and inexperienced investors often have the impression that they should send their entire penny stock holding at one go. Often, circumstances dictate that you sell part of your penny stock holding to take some of the profit and retain the rest of your position.

Whether you sell 20% or 50% of your holding will depend on the size of your investment and the future outlook for that particular stock. Don’t feel disappointed if the price continues to rise after you have sold. After all, you have a considerable profit in terms of cash in your pocket and the rest of your holding is much more valuable. Greed prompts too many people to hang on to their penny stock holding and risk losing all their gains. After all, you have made money on your trade and you can move on to the next one without kicking yourself.

You have to keep reminding yourself that you are dealing with penny stocks and if prices rise dramatically very quickly, and they are equally likely to fall as quickly and dramatically. You must always be prepared to take your decisions quickly because of the volatility of the situation. This is why you are likely to lose if you do not take at least some of the profit quickly. If you have realistic expectations of return, you are less likely to be disappointed by the perception that you have sold out too soon.

The other common mistake is in dealing with reverse splits. They can fool many investors and it is essential to understand the implications. You probably know about stock splits and how companies who are doing well benefit from the increased trading caused by the split. The reverse split is the opposite and can have the effect of increasing the price per share. It is often a sign that the company is in trouble and trying to maintain a minimum price in order to stay listed on the stock exchange. The effect is that companies trading in their penny stocks are extremely low prices can now achieve price is then begin to look a little more respectable even though the fundamentals remain unchanged. You actually have to live with the fact that your ownership share of the company has been drastically reduced and, in all probability, it is worth less than what you paid for it.

How do you figure out which stock is going to make you a fortune and which stock will give you only a nice little profit? To do this, you first have to figure out the possible upside for the company. If they operate in a static market that is not growing or is even shrinking, there is unlikely to be much upside even if they have a significant market share. However, if they have even a small share of the market that is likely to see explosive growth, their own growth is likely to be as explosive. This is all the more likely if there are significant entry barriers for potential competitors. It also helps if they hold patents or intellectual property in an exciting technology with great growth prospects.

You should then proceed to follow the company for a while before actually making a significant investment. Speak to them periodically and study their financial statements and the media announcements by management. Are you seeing a steady growth in the share price which is likely to be sustainable or are you seeing a sharp and sudden spike which is not based on fundamentals? Is the performance justifying your original assessment of the company and does it still make an attractive investment currently? Is there an increase in trading volume and does trading activity stay at a higher level? If the answer to all of this is favorable, you are most likely onto a real winner.

Take advantage of the fact that all publicly traded companies are required to have a department for investor relations. It is amazing how few investors even bother to talk to an investor relations person even though a brief conversation could make a remarkable difference to your investment decisions. At best, you will end up with a much better feel for the company and, at worst, you could end up reaffirming your decision or even pull out if you get a negative impression. Do this on a regular basis for stocks that you own because it is the easiest and cheapest method to stay on top. If you ask the right questions and listen carefully, it is possible to pick up genuine nuggets of information.

It is easy to caution people to keep their emotions out of their trading activity but this is much easier said than done. After all, human beings are highly subjective so it is probably allow for your emotions into account when making your trading decisions. For instance, you may intuitively dislike a particular company and find it hard to implement your trading strategy for that stock. Other things that you should take into account are the time and effort required to implement a particular strategy and the trading capital that is required to make it work. You should also consider the impact of the loss of your capital and whether you have the patience to see your strategy through. Finally, you should ensure that you do not suffer sleepless nights as the result of a high-risk strategy. After all, penny stocks are high-risk investments.

Because it is often little hard information that is available, you need to use every scrap of information that you can find and then determine your entry and exit points. Unlike conventional stocks, you may not have enough information for the back testing of your strategy to determine your chances of success. Conventional investment-grade stocks can be reviewed at periodic intervals but this is not possible with penny stocks where developments can often be sudden and dramatic.

As long as you make sure you diversify your investment and don’t put too many eggs in one single basket, you can probably live with penny stock investing risk. You are going to have to work hard to gather information on potential investments but, if you do not do your homework, there’s a good chance that you will end up losing money. As experts never tire of saying, the line between gambling and speculation is the degree to which you can control your risk.

One of the most important parameters of investment strategy is the time frame in which you are going to trade. It is axiomatic that, the shorter the time frame, the better your control of risk. On the other hand, if you lengthen the time frame, it can be less stressful while reducing transaction costs. Frequent trading can be profitable but requires a great deal of intensity and focus. Because you are trying to exploit narrow windows of opportunity in penny stocks, you have to stay right on top of market developments all the time. Realistically, you can succeed with fairly simple penny stock trading strategies so there is no need to complicate things for yourself. In short, there is no substitute for sound common sense.

The first commonsense precaution is to avoid trading on unregulated exchanges like the OTC BB and the pink sheets and stick to exchanges that are regulated by the SEC such as the NYSE or NASDAQ. These regulations require companies that are listed on these exchanges to submit financial statements at regular intervals that provide investors with up-to-date information about the financial health of the company and the outlook for its business. You can also obtain up-to-date information from the Internet or sources such as Reuters and Bloomberg. This enables you to carry out some meaningful financial analysis and arrive at trading decisions based on reliable information.

The second commonsense precaution is to diversify your penny stock investment and allocate a percentage of your trading capital to each penny stock investment. You will lose some money but this strategy would ensure that you are not financially crippled by a single loss. Moreover, spreading your investments increases your chances of hitting a home run and just one notable success will transform the return on your portfolio. In penny stock investing, one of the best ways to succeed is to control and limit your losses.

There are plenty of scams associated with penny stocks and you should learn how they operate in order to stay away from the more obvious ones. Despite the lack of credible information, research as much as you can and does not make any investments if you have misgivings about a particular company. There are plenty of opportunities available and you don’t have to worry about the possibility of missing out. It is far more important to preserve your trading capital.

Unscrupulous manipulators create hype around penny stocks that they wish to manipulate by pumping them up on chat rooms and bulletin boards. Take a balanced view of what you see on these sites and take the information with a large pinch of salt. If you spot any prospects from one of these sites, make sure that you check it out as thoroughly as possible before acting on the information. In many of these situations, good sense and gut feel are some of the most valuable analytical tools.

Trading will always have its ups and downs and you will win some and lose others. It is extremely important to cultivate the right attitude and not let temporary setbacks get you down. Don’t overdo the blame on yourself because you are not perfect. The best way to handle this is to take a short break from trading and figure out what went wrong. If you have several losses in succession, it may be a good idea to take a break for a while. Absolutely the worst thing you can do is to chase your losses in the hope of gains that are simply not there.

Like all stock valuation, the valuation of penny stocks is partly a science and partly an art. However, a bad stock is quite simply a bad stock regardless of whether it is a penny stock or not. Too much debt, high operating costs, uncompetitive products and services and ineffective marketing all go into the making of a bad stock. The approach to penny stock valuation differs from the valuation of large companies because you must have different objectives.

With large companies, you are looking to benefit from the appreciation in the share price. With penny stocks, you are often looking for candidates that are ripe for acquisition and hoping to get in on the ground floor. Even the prospect of a company in play, regardless of whether the acquisition is completed or not, will bring in larger investors hoping to profit and boost the share price. The trick is to get into the stock before they do.

Here are some valuation criteria that you might find useful:

• Look for improving earnings and a flat stock price. The improvement in earnings as a result of sustainable sales will ensure that the stock is bound to take off at some point in time. This is assuming of course that there are no other negative factors such as high debt and unsustainable costs.
• Look for companies with low debt levels. Many large companies will shy away from acquiring a penny stock company with little or no revenue and a mountain of debt. Large companies may even be tempted to pay a premium for companies with promising business models and low debt
• Find companies that implement share buyback schemes. The effect of a buyback is to reduce the float on the market and thereby increase the value of your existing holding. If the company operates buyback as a long-term strategy, your holding is bound to see a steady appreciation. The flip side of the coin is to avoid companies that are constantly raising capital and diluting the value of your holding just to stay alive.
• Look for penny stock companies with institutional holdings such as mutual fund investments… Not only will this confer respectability on the company but the presence of large shareholders makes company management more accountable. On their part, institutional investors will play an active role in promoting the fortunes of the business and thereby increase the value of their own orderings. Institutional ownership is rare but you should try looking.

The stocks in your portfolio will need to have a minimum level of daily trading activity (at least 50,000 shares per day on an average) and a high beta factor to indicate high volatility. Not that trading activity in penny stocks may be sporadic so you will need to consider average trading volumes over a longish time frame. Sometimes trading in active stocks can dry up overnight and you need to be in a position to trade before this happens.

If you plan to get involved in short-term trading, make sure that you can commit the time that is necessary to follow a portfolio of target stocks on a daily basis. You also need to develop the proper trading attitude and the state of mind that is required to follow through. You also need to commit yourself to a minimum investment of say $5,000. Only then will you be able to trade in penny stocks for the short term or a profitable and consistent basis.

You will also need a fast Internet connection and a dedicated computer to be able to get quotations reliably and accurately at any point of time that you wish. You will need to check prices many times every day to keep track of price fluctuations and this is best done over the Internet. An Internet connection to your broker will also help you to place orders for trading quickly and in a timely fashion.

You need to stay right on top of your buy and sell orders as well as the market action so that a particular penny stock movement does not come as an unexpected surprise. The most effective way to be profitable is to take a profit in small increments because you are more likely to see multiple movements of 10% in the price than 50%. Paradoxically, if you are seeing profits consistently in the 50% range, you are not trading at the right frequency and your chances of losses are bound to increase.

You will be trading more frequently than a value investor and commissions will form an important part of your costs. If you are not already using a discount broker with rock bottom commissions or if you pay too much per trade, you will find your trading profits being eroded substantially by your transaction costs. This is further exacerbated by the fact that your buy or sell orders may only be partly fulfilled and your commissions are therefore being paid out on smaller trading lots. Try and rework your target prices and adjust the quantity of each order rather than place multiple orders and multiple commissions.

The first thing to understand is how a market maker operates and what his role in the penny stock investment business is. The market-maker is a penny stock intermediary who buys and sells penny stocks in lots of 100 shares. The system allows for market makers to set their own prices for each transaction. This can benefit you both in terms of price and liquidity if you deal with a good market maker. Obviously, it helps to have several market makers for the same stock and the names for any stock will be listed for your convenience on the pink sheets.

You will next need to understand a little bit about how penny stocks are manipulated. You will recall that not all brokers work for your benefit and many of them are in business to see what they can get out of you. Let us examine how the typical manipulation works:

• Normally only one unscrupulous market-maker is involved. The market maker buys a very large quantity of a particular penny stock and pays very little for it.
• He then proceeds to create a market for stock by whipping up sales. He will build up by buying interest by misrepresenting or just exaggerating the prospects for the stock. He can even create some kind of fictitious financial news or development to hype the stock. He may also use online penny stock forums to push his worthless stock.
• He then sells stock to willing buyers who have been duped by his hype.
• Inevitably with all this buying activity, the stock price will rise sharply and the manipulator will turn a nice profit.
• When buying activity ceases, as it must at some point in time, the price will drop sharply and the unsuspecting buyers will be unable to exit from their investment. Even if they manage to sell, they will end up losing a lot of money. In some cases the unscrupulous market maker may buy back the stock and proceed to dupe other ignorant investors.

Penny stocks often hit the market by way of what is known as an Initial Public Offering (IPO). This is a term used to describe the first offering of stock to the general public and any company looking for investment by way of equity from the public will need to start with this process. Naturally a steady flow of IPO’s is required to keep any market fresh and vibrant. Because the penny stock is issued by the new business, it is not automatically mean that the stock is worthless. Every large company worth its name begins life as a small business.

You should not be deterred by the fact that you’re dealing with a relatively unknown company because there are some ways in which you can research the company. The first thing that you should do is to try and call the company over the telephone. This is a good way of picking up information about the company personally and at first-hand. There is how to go about it:

• Get the company’s phone number and address from the broker who is selling the penny stock. You are not obliged to disclose to the broker why you want this information and what you are going to do with it.
• Even if you cannot get this information from the broker for any reason, try and find alternate numbers for the company from other sources. You can also try an online search to see what information about the company is available on the Internet.
• In fact, if you are unable to contact the company, this is a good reason to walk away from the investment. After all which legitimate business would not make it easy for potential customers to get in touch.
• If you do manage to get through, start by saying that you’ve heard about the company and that you would like to know a little bit more about them such as the exact nature of their business, their customer base and so on. Any legitimate company would only be too happy to provide you with this kind of information.
• You can pick up a lot of clues about the company from the way they handle your own call. Do you get the impression that they are a legitimate business or merely a front for manipulators to respond to potential investors? If you feel that you are connecting with a home rather than a legitimate office, there is a good possibility that the transaction is a scam.
• You obviously do not have adequate information on the company as yet and you can pretend to be a potential customer. This will give you a good chance to acquire more information about the company and its products and the way they handle potential customers. After all, if they do not have good customer service, their business can hardly be expected to flourish. If at the end of the day, you get the feeling that the business is not legitimate, go with your instincts and avoid making the investment.