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.

How do you find these genuine investments? This is a hard question to answer but if you can find a fresh and exciting new business and hold on to your investment through the difficult years while the company establishes itself, you have a genuinely good chance of hitting the jackpot. Here are some guidelines for the selection process:

Spend time and effort on doing your homework so that you can establish that the business is genuine and the service on the product being offered has a good chance of succeeding in the markets. There is little to be gained by investing foolishly and without thought. You may as well have a flutter at the races where you have the benefit of the fresh air and the sunshine

Only risk capital that you can afford to lose completely without suffering financially. If you take the attitude that you are going to lose your entire investment on penny stocks, any profits that you make will come as a refreshing change. However, don’t go to the other extreme and stint on your investment because you will miss the opportunity to pick up the shares when they are still cheap.

Have the patience to hold onto promising investments. If you’re making a long-term investment, the highest returns will come only in the long term. New start-up businesses need time to find their feet and to establish themselves and to survive the first few difficult years. Whilst business starts to pick up and profits and sales start to grow, the stock price will automatically follow. Resist the temptation to sell quickly and have faith in your research and homework. Ignore any short-term fluctuations and, above all, do not panic if there are any adverse short-term fluctuations

Because the right broker as critical to your success, always bear in mind that penny stocks attract unscrupulous brokers just as honey attracts the bees. If all your existing broker is doing is pushing you to buy penny stocks, chances are that he is not the right broker for you. After all, what you need is a broker who can offer disinterested and impartial advice and tell you both when to buy and when to sell. You are probably better off not going to a broker who specializes only in penny stocks. A broker with a broad-based business is less likely to scam you when it comes to buying and selling penny stocks.

If you are an experienced investor in stocks, you will already know that brokers can wear two hats:

• Broker as your agent. In this case, the broker is working for you and your objectives are his objectives. He works as a pure middleman in buying and selling stocks for you. Usually you will tell you broker what to do and he will carry out your instructions faithfully. He is paid to work for you on a commission basis.
• Broker as principal. In this case, the broker is essentially working for himself though he may execute your buy and sell orders.

He is making money from the bid/ask spreads rather than from commissions and your interests are not his primary interests. Many penny stocks are traded in this fashion and, while the broker is unlikely to cheat you outright, you must bear in mind that there could be a potential conflict of interest.

With penny stocks, your selection of the right broker is of great importance to your successful trading. The problem is that many reliable and trustworthy brokers do not deal in penny stocks so you have to find a broker who deals in penny stocks and yet has the qualities that you are looking for. Here are some tips on how to find the right broker for your penny stock trading:

• Try and get to know your broker properly. Talk to them in detail and make sure that the two of you are on the same wavelength. Trust your gut feel and if you don’t feel comfortable working with him, find another broker. Equally, if you feel that he is not reliable and trustworthy, then don’t continue to work with him. You should be right at the centre of his attention and, if this is not the case, you are likely to suffer down the line.
• Get a feel for his track record and how successful he has been with other clients. If he has done well with them, he is sure to tell you plenty of interesting stories from which you can gauge how he has done. Don’t let him pressure you into taking a decision to work with him. If he gives you a blatant sales pitch rather than a reason argument, he has probably working for himself and not for you.
• Test his knowledge of penny stocks. If he really knows his stuff, he should be able to answer any questions that you ask comprehensively on the spot and without giving you a runaround. Talk about your investment objective and see what he comes up with or by way of a plan or a strategy. A good broker should be willing to spend some time with you creating a plan to achieve your investment goals.

Everybody knows, to some degree, that risk is associated with safety and that it exists wherever you are unsure of the outcome. In other words, there is a chance that you could lose money. There is a degree of risk associated with all forms of investment move but some forms of investment are riskier than others. For instance, some stocks are less risky or safer than any stocks because there is of a chance like the price will drop sharply and that you will lose money. However, this very safety makes it far less likely that you are going to profit hugely from the stock. What makes these stocks safe is that the company’s business strategy makes for lower volatility and this means that there is not enough room for the price to drop sharply. Yet the same lower volatility means that the stock is unable to gain sharply.

On the other hand, risky stocks like penny stocks are risky precisely because they are far more volatile and this volatility could result in large profits or losses. This volatility may be because the company has good potential but does not have a stable business or because it may be a start-up or new business without a track record. The trade-off between risk and reward means that the higher the risk, the higher the potential reward (or potential loss as the case may be). Almost without exception, all penny stocks are risky stocks and it is very difficult to stay safe while investing in these stocks. You must realize when you put your cash on the line that often these are all or nothing kind of situations. The risk factor means that seemingly shaky stocks have delivered outstanding returns while seemingly promising stocks have tanked quickly.

It is entirely up to you to determine what your risk tolerance is and how much risk you can manage. If you are an entirely risk averse investor, then it is certain that penny stock investment is not for you. If you have a reasonably high risk tolerance limit, you can then consider actively investing in penny stocks. You must understand that you should be able to write off the money that you invest in penny stocks without suffering any form of financial hardship. Naturally, nobody makes an investment in the expectation of losing money but the risks associated with penny stocks means that you must face up to the prospect. The good news is that there are ways in which you can pick the most promising penny stocks and implement strategies to minimize your losses while maximizing your gains. The bad news is that there is no surefire protection against losing your entire investment.

The first thing that you should learn is the difference between bid and ask prices. The bid price is the price at which somebody is willing to buy the stock and is the price that you will get if you choose to sell your stock. The ask price is the price at which somebody is willing to sell the stock and is the price that they would expect if you are buying the stock. It is important to understand these terms properly so that you can set a proper price for both bid and ask transactions. The second thing that you should learn is what a spread is. The spread is the difference between the bid and ask prices. You have to take the spread into account when you are calculating your transaction costs in addition to other costs such as the commission that you are paying. For instance, if you are selling a penny stock, you should at least cover your costs and your ask price must include a spread that is sufficient. The spread can be as much as 100% though in normal cases, it would range between 25% and 40%.

You may be confused by the fact that many penny stocks actually have two bid prices and two ask prices which are known as the inside and the outside prices. These prices actually reflect the range in which both the bid and the ask prices operate and you will generally want the lowest bid price and the highest ask price. You should note that there is a phenomenon called mark up pricing in which some brokers or dealers will mark up the price to a certain extent to compensate them for holding an inventory of the stock. The inventory enables them to act as market-makers and the markup could be an additional cost for you.

All said and done, how do you get the best price for your penny stock whether you are buying or selling? The best way to achieve this is to consider all the details of the entire package. In a typical trading situation, you are likely to get the best deal from a broker who is acting as your agent because he is acting solely on your interest unlike a broker who acts as a principal. A good broker will always look out for the best prices for you. Unfortunately, in many cases, you will be dealing with a broker-dealer who is acting as a principal. In this case they will be compensated by the bid/ask spread as well as any markup that they may employ for acting as a market-maker.

The quantum jump in penny stock trading on the two most common penny stock exchanges, the OTC BB (Over the Counter Bulletin Boards) and the so-called Pink Sheets testimony to the number of investors who are looking for sky high returns. It is the fact that many of these investors are induced into these investments by misleading information and hype and very few of them actually realize the risk that they are taking. We will take the case of an actual stock called CMKM. The share was actually trading at $0.0001 and you pick up one million shares for a total investment of $100. If you are lucky to sell the share at $0.005 (a price that the share hit several times), you would make a profit of $4900 which is a stupendous return on your investment of $100. If you were on the reverse side of the trade and bought at $0.005 and sold at $0.0001, you would be left with only $2 out of your original $100.

How do you go about making sense of all this and trade penny stocks? Technical analysis could possibly be one solution. However, given the recent development of this phenomenon, there is not a great deal of historical data that you can use to establish charting patterns and use indicators properly. Moreover, because of the low values of the stocks, the entire process of charting will have to be completely redone to take into account minute fluctuations in price because they are significant in the context of penny stock trading. The other problem is that many of these stocks do not trade in volume and this makes technical analysis unreliable. Many penny stocks also tend to be manipulated in the markets and this defeats the entire purpose of rigorous and objective analysis.

As a result of these manipulations, penny stock prices tend to be driven by misleading hype and misinformation and not genuine market factors, because technical analysis will not work, probably the only way of dealing with penny stocks is to keep track of the buzz online. The intensity of the buzz will serve to signal when a large price movement is about to take place. If you combine this with information about how many investors are involved and how the price is being manipulated, you can still make money out of trading penny stocks without using the orthodox analysis.