How to Find The Best Penny Stocks
Penny Stocks are an anomaly to most investors. They are always swinging wildly in both directions, and are consistently the biggest gainers and losers in the stock market during each trading session. Penny stocks are extremely speculative and risky investments, but there are ways to systematically reduce your exposure and hedge away risk.
Before attempting to trade anything, I would strongly recommend reading Edwin Lefevre's Reminiscences of a Stock Operator.
So let's learn a bit about Penny Stocks. Why do Penny Stocks rise and fall with such volatility? Well the reason behind this is relatively simple. Penny Stocks are pieces of businesses with very small market caps. What does this mean? It means that the total value of the business to the equities markets is relatively low. For instance, if there are 1,000,000 shares of Company X outstanding, and the share price is $0.09 per share, the equity value of the business is only $90,000. This is especially important to understand, because even though a share of stock priced at $0.09 seems cheap in absolute terms, it may be very expensive relative to the actual value of the company as a whole. Or, conversely, it could be very cheap relative the value of the business.
So how do you know how to find the cheap stocks and stay away from the overpriced penny stocks? It’s not that easy. But with a simple mix of fundamental analysis coupled with a smattering of technical charting we should be able to weed out a couple of winners from the morass of penny stocks out there.
The first step is to choose a market that you are somewhat familiar with. The goal in investing is to understand how the company you are investing in makes money, which in turn, will allow you to make the most educated decision possible. So once you have chosen an industry, let’s say Automotive, perform a screened search on Google Finance for small market cap, low priced securities in your chosen sector (transportation).
Once you have used the Google Finance stock screener tool to reduce your stock universe to a handful, choose two or three to do some preliminary research on. You want to look for recently filed financial statements. Now, be aware that since these are penny stocks, many of them will not be listed on major indexes, and therefore, will not be required to file financials on regular intervals. A promising company will file them anyway, these are the ones you want to look for. The filings will be called 10-K, 10-Q etc. depending on the time of the filing, Annual or Quarterly respectively. You’ll want to read through these and listen to what the financials tell you. Look at the balance sheet, get comfortable with their current assets versus liabilities. Get an understanding of future cash flow sources and make a determination as to whether you feel that these can be realized in the near term. Stay away from over speculative business models. Look for companies that have products to sell, these have the least chance of losing significant market share.
Once you have gained some comfort in the fundamental aspects of penny share research, it’s time to find the best penny stocks from a technical perspective. Technical research is a little more involved than fundamental research, but it doesn’t have to be rocket science. What you want to do is take your chosen stock ticker and plug it into Google Finance. This will give you a chart. Set the interval to Daily, add two simple moving average indicators, a 50 day and a 200 day. If the 50 day moving average line is below the 200 day moving average line, only jump in if it has been closing the gap upwards. If the gap has been widening on this graph, stay away. Similarly, if the 50 day moving average line has recently crossed the 200 day moving average, that is called a Golden Cross, and is generally considered a bullish move. You should consider buying at the point of the cross.
As with any highly speculative investment, only invest in penny stocks if you can afford to lose your entire investment. This is not meant to scare you away, but is meant to convey the fact that nothing is certain in the world of Penny Stocks. Do your homework and mitigate your risk, but don’t be fooled into thinking any Penny Stock investment is a sure bet.