Questions and AnswersUnderstanding Penny Stocks by Peter Leeds

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Intermediate Level Questions

Can penny stocks give me short-term trading profits?

Absolutely. Penny stocks by their very nature are highly volatile investments, and are usually very speculative.

This means that they can return gains of hundreds or even thousands of percentage points, while you may only see returns of 5% or 10% in more conventional blue chip stocks over the same period. They also inherently contain more risk.

questions for traders

How can I research companies that I am interested in?

Visit our discussion on the sources of information for penny stock investors.

Penny stocks are generally more difficult to research due to a lack of visibility, and it gets worse if they are not traded on a regulated exchange like the NASDAQ.

I also highly encourage you to apply our long-secretive penny stock analysis methods to any stocks you are interested in. The fundamental and technical analysis techniques we use are called Leeds Analysis.

Should I buy that stock I heard about at work? It sounds promising!

I highly discourage using 'tips' from friends and co-workers as a basis for coming up with penny stocks to invest in.

I know that the particular penny stock sounds amazing, and I know that you feel you had better not wait too long, or you will miss the boat. Just please do yourself this one favor first: review our discussion called, Watch Out for These Dangers, to see all the ways that tip will cost you.

You will then understand why you should steer away from these types of penny stocks, unless they pass a serious fundamental screening like Leeds Analysis.

How much should I invest in one penny stock?

While that depends on your own financial position, your tolerance to risk, and your own trading aggression, we feel that levels of $1,000 to $1,500, or even as high as $2,000 per stock is most appropriate. This effectively makes the commissions only a small factor in the total trade. As well, it helps you avoid driving up the price yourself if your buying volume is high.

You need to diversify over several penny stocks if possible, even if this is at the expense of your total investment per stock. A trader with $1,500 total may want to buy two or three different penny stocks, while a trader with $5,000 may also only want to buy three penny stocks.

How many penny stocks should I hold at one time?

The more the better. You will benefit from diversity if you spread your invested capital around several stocks. However, it will depend a lot on your own trading philosophy. What is best for one person is not best for another.

As long as you are using money you're willing to risk, and you're not putting too much money into any one penny stock, you should hold as many different companies as you feel comfortable with.

A trader with $1,500 for penny stock trading may buy two or three different companies, while a trader with $5,000 may also buy two or three companies, but would also have the option of diversifying among five or eight, or maybe even more.

In all cases, it is best to keep some cash on the sidelines. Having $3,000 to invest doesn't mean you have to put all of it into penny stocks right now. Watch the activity of your favorites, and accumulate positions in them when they reach your target buying prices. If buying opportunities do not present themselves, watch and wait. There is no rush, and the next great penny stock opportunity is always just around the corner.

As long as you have some cash on the sidelines you will be able to take advantage of buying opportunities as they arise.

Should I go short-term or long-term?

It really depends on the penny stock, but in many cases it is best to go short-term.

In some cases it is prudent to hold penny stocks for longer time frames, and as much as several years. This would apply to companies that are solid, and have legitimate prospects, and just need some time to demonstrate the effectiveness of their operational strategy and business plan.

The important thing to remember is that you should not be holding a penny stock because you are frustrated with it, or because it has fallen below what you bought it at, or because it has not done much and you are waiting endlessly until it makes a move.

Before you get involved with a company, have a clear idea of how long you would intend to hold the shares and why. If the penny stock has not performed as you would expect in that time, you should take another look at the situation, and perhaps move on to other investments.

How do I check out a company to make sure it's legit?

Legitimacy is not the problem. It is the legitimate companies that are so poorly run, or are based on a faulty business plan, which will cost you 100% of your investment as they tank. You will lose just as much with these as with some made-up promotional scheme.

Checking out the legitimacy of a company is a lot easier with penny stocks that are trading on the AMEX or the NASDAQ (or the Canadian exchanges like the TSX or CDNX), than it is for pink sheet penny stocks.

Pink sheet companies are not subject to very significant reporting requirements, or any official form filings that would prove their legitimacy. Most companies traded on there have serious concerns, from a Leeds Analysis perspective.

Organizations like the Better Business Bureau are of little help, because illegitimate companies can easily change their name from time to time as cover, and the BBB is generally a powerless organization to begin with.

You should also be wary of the company web sites, because there is no method of telling fact from fiction when you are on their page.

The best approach involves a combination of phoning the company, e-mailing their investor relations contact, and reading the press releases. As well, make sure to review any documents filed with the SEC (Securities and Exchange Commission), such as their corporate financials and "Management's Discussion and Analysis" annual report.

We suggest limiting your penny stock investments to those shares trading on the NASDAQ SmallCap, the AMEX, and the OTC-BB. That way you won't need to worry about the legitimacy of these corporations. The exchanges have already done the job for you, before granting listing approval.

Why wasn't my trade order filled?

With all specific trading questions you should first go directly to your broker. As well, you can also refer to the section on trading penny stocks.

If your order was not filled (or was only partially filled), your limit price may not have been high enough (or low enough if you were selling) to match any traders on the other side of the deal. In other words, I can put in an order to buy IBM shares at $1.00, but the order will not get filled because I am not paying enough.

If your limit price was reached during trading, but you still did not get the shares, you need to remember that the exchange takes orders in the order in which they are received. For example, if someone puts 10,000 shares for sale at $1.10, then afterwards you put 2,000 for sale at the same price ($1.10), your shares are 10,000 deep. Even if buyers meet the $1.10 price, they would need to gobble up 12,000 shares for your order to be fully filled. If they only took on 4,000 there would still be another 6,000 ahead of you, and then your 2,000.

In this example, if 11,000 shares were bought at $1.10, that would leave you with a partial fill: 1,000 sold at your asking price, and 1,000 did not so you still own them.

Why does this penny stock show no trades or volume?

Often a penny stock will go the full day (or several days) without the bid and ask prices meeting up, which means no trades take place. This is usually more common with very thinly traded penny stocks. If there is not enough investor interest, and those traders that do get involved can not agree upon a price, there will be no activity in the underlying stock.

Alternatively, if a stock is halted it will be unable to trade.