5 Rules for Picking Good Penny Stocks
In order to profitably and consistently pick penny stocks, you need to establish some ground rules. This will keep you from buying penny stocks doomed for failure, and direct you towards penny stocks that have good potential. This pertains to short term trading of 1 to 2 weeks per trade, in case you are wondering what time frame of trading I’m referring to.
Rule #1 – Make sure you only consider trading stocks with a good amount of dollar volume. This is a way of saying liquidity. Reason being you don’t want to put a thousand dollars in a stock that is only trading an average of five thousand dollars of trading volume per day. To calculate dollar volume estimate, simply multiply the number of shares traded in a day by the closing price of the stock (or slightly above or below it).
Rule #2 – Never put more than an amount of capital that is equal to five percent of the daily trading volume in one penny stock. This could be disastrous for you if you fail to understand the lack of liquidity in many penny stocks. Some traders get excited to see big gains on paper, only to have a very hard time realizing those gains when the time comes to sell. This is without a doubt due to lack of understanding about liquidity issues in penny stocks. Don’t let this deter you from trading penny stocks altogether, but use caution.
Rule #3 – Check the catalyst that is creating excitement behind a penny stock. So, you see people on message boards excited about a particular stock. Take the time to read the news/rumors for yourself. As you get some experience under your belt, you will realize what sort of news events will drive penny stocks higher. Try to verify any rumors before you put any money into a penny stock.
Rule #4 – Learn the basics of technical analysis, also known as charting. You don’t have to become some sort of world renowned chart wizard, either. I am simply referring to learning things like support, resistance, trend lines, break outs and break downs. Do not be discouraged if you have no experience with charts, you can recognize the basics after studying just a few charts that are annotated.
Rule #5 – Bounce your thoughts off of other experienced traders. Sometimes having friends who also are knowledgeable about penny stock trading will benefit you. They can help reassure you when you find good stocks, and help prevent you from making bad trades. I realize most people do not trade penny stocks, so these will most likely be people you meet from penny stock sites such as message boards and newsletters.
To conclude, you should take some time to understand the basic realities of penny stock trading before you put your own hard earned money at risk. There are certainly no guarantees with penny stocks, but then again the opportunity to make tremendous returns in a short period of time makes it worth the risk. Some people like subscribing to penny stock picking services that take some of the legwork out of the picture.