How to Intelligently Trade Penny Stocks

First off, if you are going to "play" the Penny stocks, you should be trading the majority of them and not investing in them. You'll understand why shortly.

Penny stocks are normally those that have a share price of $5 or less, with many being under a penny. Those stocks that sell for less than a penny are called "subbers", as they are a sub-penny in value. Some actually trade in the hundredths of a cent.

The majority of the pennies and subbers trade don't trade on the higher exchanges, such as the NASDAQ or AMEX, but rather on the Pink Sheets or the Over the Counter Bulletin Board (OTCBB). This is due to them not meeting the minimum requirements of the higher exchanges, primarily because they are emerging, small companies in the development stage.

Before getting into the actual nitty gritty of the trades, you will need to meet your own requirements before trading:

- Most importantly, never trade with money you can't afford to lose! Read that again. Too many people take money out of savings, their paychecks, etc., that is needed for their daily expenses. The worst case is taking out a loan to "invest in a sure winner". Greed kills. Mortgage or rent goes unpaid, marriages suffer, etc.

- Find a broker that has online trading AND also will allow you to trade in penny stocks on the Pinks and OTCBB. Not all do, and you don't want to take the time to set up an account and find out later that you can't trade the penny stocks. Check first before signing up!

- You will eventually migrate to a trading forum board on the Internet and discover all sorts of great picks - not! The message boards are dangerous to your trading account for a variety of reasons. More to come on this below.

- Learn this term and apply it every time you think you want to buy a certain stock: Due Diligence, or DD. This involves researching everything you can find on the stock, and only factual, verifiable information. Some of the resources are the company's own web site, official press releases (PRs), web sites such as Yahoo Financial, The Pink Sheets, InfoQuotes, etc. One thing that is NOT DD is getting info from the message boards, unless there is a verifiable source.

- Have an entry point and an exit strategy. Don't buy into a buying frenzy, as the stock will most likely retrace down shortly after. Look for a good buying opportunity entry point. Decide on an exit point: how much do you want to safely make? You can put in a "stop" on your account that will normally automatically sell your shares if the price drops to the level you set your stop at. Some people want to risk only 30%, for instance, and set a stop for a 30% loss. A really good method is to use a "trailing" stop to lock in profits. If you set a trailing stop for 30%, as the share price climbs, your stop trails along behind the new share price.Message boards - these are very dangerous due to the anonymity of the people posting messages both for and against the stock. You have no idea who or what agenda the posters have. "Pumpers", who continually post outlandish positive claims that are outright lies or exaggerations, and "Bashers" who do the opposite, inhabit these forums. Their agenda is to drive the price per share up or down, depending on their particular agenda.

The amateurs, or "newbies", that sign onto these forums will wind up following the posters who tell them what they want to hear, regardless of reality. We all want our stocks to skyrocket, so we tend to listen those pumpers who satisfy our psychological needs and ignore the people that question not only the pumpers but also the company itself. A really good board will allow free discussion of both sides as long as the posters can substantiate their claims. Flame wars are all too prevalent on a lot of these forums, and should be avoided. It's nothing but noise and distraction. By the way, DD is NOT listening to a pumper or a basher on the boards!

I mentioned in the beginning that you should trade and not invest in these penny stocks. The land of pennies is littered with the victims of scam artists, both involving the companies themselves and people not affiliated with the company. You see, penny stock companies trading on the Pink Sheets have almost no responsibilities to the "investors" or to the SEC. They don't have to report their financial figures nor the number of shares authorized and outstanding. This leads to unscrupulous people who set up a penny stock company very easily and then issue millions, and sometimes billions, of shares. They then pump themselves on the message boards and give the false impression the company is going to make millions of dollars on something. The price per share goes up, people notice and start buying more, and the buying frenzy starts. But, the company CEO and his henchmen start selling into the frenzy, making a fortune. Guess what? You lose.

The other hazardous maneuver is the "group play". A few people get together, buy up tons of very cheap shares of a pink sheet company that's going nowhere. They then start pumping the hell out it on forums and sometimes emails to subscribers. The buying frenzy begins, people don't want to miss out and load up with more shares, and the scammers sell their shares into the buying frenzy similar to the CEO scenario above. They make a killing; the price per share starts dropping back to the original price or a lot of times below it. You lose. Again. Get the picture?

Bottom line: don't invest long term in these companies. Watch the trading patterns, get into one that starts going up, and take a quick profit and get out. Repeat this a number of times and you start building up your account. DON'T get emotionally involved or married to the stock. The vast majority of penny stocks go out of existence and leave the "investors" with worthless stock.

If you really feel that the company just might be a good long-term play, you should sell just enough shares when the price rises to get back your original cost. Then you have "free" shares riding for the long term. If it skyrockets in a year or two, you have a great profit that cost nothing. If it goes bankrupt, then who cares - it didn't cost you anything and you still have the original money to play other stocks.

Play it smart and learn everything you can from the tremendous resources available on the Internet. And good luck!