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.

In the first place, the major stock exchanges such as the NYSE and NASDAQ should be viewed as exclusive clubs who are selective about membership. They have stringent rules about granting and retaining membership because their reputation rests entirely on the quality of the companies that are listed with them. Restricting membership to companies with good credentials and financial strength is the only way to ensure this quality and this filtering process tends to keep out smaller companies that w may compromise the reputation. The listing requirements include the payment of substantial fees and other conditions include a minimum number and value of shares outstanding that are owned by the public as well as a minimum share price. A company that does not meet these and other requirements has no chance of being listed.

Once the company has been listed, that is not the end of the story. The company must continue to meet certain minimum requirements in order to stay listed. Compare this to a school where you must maintain certain minimum grades in order to continue studying at the school. And this will continue to ensure credibility with investors who are assured that the companies whose stock they want to buy or sell have a certain minimum substance. These requirements are similar to the initial listing requirements and the exchanges charge a fee for the maintenance of listing.

If the company fails to meet these ongoing requirements, they get thrown out of the club and this process is known as delisting. You will understand this better if you realize that penny stocks are easily manipulated and small price differences can translate into large returns which are sufficient motive for the manipulation. The reputable exchanges do not wish to be seen as part of this manipulation process and therefore delist stocks that become penny stocks and can be subject to manipulation to the detriment of the reputation of the exchanges.

When a company is delisted from a major stock exchange, there are two exchanges on which it can continue to be listed. The first is the OTC BB (Over the Counter Bulletin Board) which is an electronic trading exchange that is operated by the Financial Industry Regulation Authority. This exchange has relatively lax listing requirements and the company only needs to provide up-to-date financial statements in order to trade. The second exchange is called the Pink Sheets which is considered even riskier than the already risky OTCBB… This is a quotation service that has virtually no regulation or minimum requirements and stocks that trade here are highly risky and speculative… They are also easily manipulated.

-The first misleading tip that you will encounter is to buy companies that make products that you love. In the first place penny stock companies normally small companies and you are unlikely to be familiar with their products or services. Generally speaking, another key factor in profitability is the price and you will generally tend to overpay for stocks that you really want in your portfolio. A company that produces a product that you love may be a great buy at $100 but a terrible buy at $250. This kind of concentration on a single factor instead of analyzing the situation as a whole requires you to buy the company whose products you love regardless of the price and this is a surefire recipe for disaster.

-The second misleading tip is to buy companies who are in businesses that you are familiar with. Now experienced investors who have the experience of dealing with a range of companies will not find it difficult to practice this. However, if you are a newcomer to investment, you are severely restricting the universe of your investment to only the businesses that you are familiar with. Normally, this would leave you with very few investment options. Besides, you cannot manage risk with diversification because of the restricted investment opportunities. Moreover, penny stock companies are often start-up or new businesses where you may be entirely unfamiliar with a product or service being offered. You may actually miss the chance of getting in on the ground floor on the next Microsoft or Apple though, admittedly these opportunities come far and few between.

-The third misleading tip is to concentrate your energies on diversify your portfolio. It is true that in the case of penny stocks, diversification is a must because of the high-risk nature of the investment. A diversified penny stock portfolio does offer the advantage that if you hit a home run even on one stock, you will offset the losses that you make on the others and probably show a handsome profit besides. Proper diversification requires a great deal of knowledge and planning and the selection of the appropriate stocks is critical to the process. If you diversify for the sake of diversification, you are likely to end up holding 10 dud penny stocks instead of a couple and the results will be just as disastrous.

The stocks can be traded on any exchange though you will tend to find the majority of them on NASDAQ or the Over and Over the Counter Bulletin Boards (OTCBB) because these exchanges tend to have listing criteria that are not stringent. Here are three good reasons why you should take a close look at investing in penny stocks:

The potential for growth. All of the successful large businesses, whether you’re talking about Microsoft or Apple, started life as small businesses and then grew to where they are now. If you can identify and invest in these companies when they are still relatively small, you can multiply your capital at a rate that would be impossible to attain with investments in large companies. It is a fact that large companies tend plateau in growth as they become larger and all of their explosive growth tends to take place when they are relatively small. It is much easier for the $250 million company to double in size than the two billion-dollar company.

The lack of institutional investment. When you talk about the stock market, generally, institutional investors tend to have an advantage when it comes to investing in high-growth companies. They also tend to drive up valuations. However, in the case of promising penny stocks, because of regulatory and other factors, institutional investors such as mutual funds find it difficult to take large positions. As a result, you may be able to find penny stock investments in promising companies directly without having to invest via institutional investors. Because this reduces the cost of your investment, your returns are multiplied according.

The absence of research coverage. Much of the analysis and research that you will see deals with large companies and penny stocks tend to get ignored by the investing community. As a result, if you do your homework carefully, it is possible to spot penny stocks that are undervalued with regard to their potential and you can create opportunities to benefit from their growth.

You should however bear in mind that the disadvantages of investing in penny stocks are the high risk factor and the amount of time that you will have to invest in research. The high risk factor with these small companies is that they may create successful business models when they are small but tend to collapse when they are required to scale up. Being small, they lack the resources to survive a sustained business downturn unless they are exceptionally well capitalized.

What are cheap penny stocks? Before we look at that, let’s first define cheap stocks. Cheap, with regards to stocks, does not directly correlate to the market price of the shares. In reality, if you want buy cheap stocks, they you are looking for stocks that are priced low relative to their intrinsic value.

For example, if you want to buy a TV and when you shop you find two. TV A is priced at $500 with a 10% discount for an overall price of $450. TV B is priced at $2000 with a 50% discount for an overall price of $1000.

If we look at the concept of cheap we can easily say that the overall cost is less for TV A and therefore cheaper. However, if we look at the value of TV B we see that we are gaining $1000 in value for putting the same amount on the table. Therefore, TV B is significantly cheaper.

When trying to buy cheap penny stocks, we must look at the stocks for what they are, stocks. A cheap stock is a cheap stock regardless of the overall cost. With stocks we want value, not price. Think TV B. The reasoning is simple. You may not be able to resell your $2000 TV, but you can easily resell a share of stock. So buying value that is under priced gives you significant profits upon sale.

So if you want to buy cheap stocks, you buy an under priced share. Penny stocks trade in this exact same manner. You buy cheap penny stocks when you buy penny stocks that are drastically below market value.

Think about this. You can buy GOOG when it trades at $400, at a low price of $200. You double your money because you buying below what the stock is valued at. How about a penny stock that is trading at $.50 but worth $1. Again, you double your investment. The principle holds.

If you want to eventually buy cheap penny stocks for trade, then you must learn how to buy cheap penny stocks.