Can I utilize investing strategies for penny stocks?

Penny stocks aren’t really suitable securities for investing, as most people understand the word. But they do have an undeniable appeal for a certain type of trader with an appetite for risk and volatility. Some make winning trades frequently enough to offset the inevitable losses that come with penny stocks. When you think of investing strategies, the four that are most common for traditional securities and other less volatile assets are value investing, growth investing, dollar cost averaging, and momentum investing. Let’s look at how these work with penny stocks.    
 
Value investing is definitely a long-term strategy best suited to finding bargain stocks to buy and hold, on the assumption that these securities are undervalued based on their underlying fundamentals, and therefore will outperform the market over time. Value investing depends on careful analysis of the stock’s financials. It’s definitely not a strategy that works for penny stocks, simply because complete financial information is rarely available about most penny stocks, and because they are not designed for long-term investment.    
 
Growth investing is more focused on future earnings. Although you’re looking for a big mover, it’s definitely not a speculative style of investing. It depends on careful analysis not only of the stock in question, but of overall economic factors, the potential demand for the company’s product or services, and the company’s management team. Although it isn’t a strategy solely for long-term investors, it definitely requires a commitment of a period of years. Again, this isn’t a strategy well suited to most penny stocks. Dollar cost averaging involves making regularly scheduled purchases of the same stock, regardless of price.  
 
The idea behind dollar cost averaging is that by making purchases on a schedule, you’ll pick up some shares when the price is lower and some when the price is higher, which usually lowers the overall average price per share for that security.

Obviously, this isn’t a strategy to implement with penny stocks, because the key to success trading penny stocks is timing your trades. That leaves momentum investing, which is a form of technical trading that relies on patterns in stock prices to inform buy and sell decisions.
 
This isn’t a strategy to employ with buy-and-hold investments, but it is well suited to penny stocks. The major drawbacks are that it requires a substantial time commitment to watch the markets in order to identify the conditions for a favorable trade, and that there will be substantial trading costs, because you make far more transactions as a momentum trader than as a buy-and-hold investor. Of the four investing strategies, momentum is best suited to the penny stock trader. If you can identify resistance and support levels and know how to differentiate between a valid rise in price versus the pump phase of a pump and dump scheme, you may be able to make successful penny stock trades.    
 
If you’re going to use technical trading with penny stocks, you should still keep a few pointers in mind:

  • Know the difference between market trends and hype. Penny stocks run on hype, so just because a company is in a hot sector doesn’t mean it’s a hot stock.
  • Pay attention to volume and liquidity. Your ability to make money on a well-timed trade depends on actually finding someone to buy or sell the stock. Penny stocks are notoriously illiquid; most successful traders avoid those with less than 100,000 average daily volume.
  • Shorting pennies is extremely risky. This is an irrational market and stocks can swing 100% or more in a very short time. It’s almost impossible to predict where a run will end.
  • Choose your indicators carefully. Moving averages are almost always good, as are Fibonacci retracements, but once you find one you like, stick with it. Remember, you’re using them to help you make good trades, not rehash and justify ones you already made.
  • Know when to get out. If you can take a 10% or 20% profit, do it and move onto the next opportunity. Too many penny stock traders forget that runs don’t last forever, and they hang on way too long out of greed.

 
Remember, penny stocks are extremely risky and extremely volatile. They are not the sort of stocks you stake your retirement or other long-term money on. If you’re going to trade in penny stocks, use money you can afford to lose, because most people will lose in this market, especially when starting out.