How to Learn to Invest in Penny Stocks

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Many startup companies in need of capital will issue stock at $5 per share or less. These stock shares are commonly known as "penny stocks," since some of them trade for $1 or less. The low cost of investing in penny stocks, as well as the stories of high returns and quick turnarounds, have made penny stocks an attractive option for some investors. However, you should learn more about the risks involved in penny stocks before making a significant investment.

Do Your Homework

Investing in the stock market at any level carries substantial risks. Investing in penny stocks magnifies many of those risks. Anyone interested in investing in penny stocks should understand the differences between penny stocks and stocks found on the "big boards," such as the NYSE and NASDAQ. For instance, penny stocks are largely unregulated. Unlike companies that list on the NYSE or NASDAQ, penny stocks are listed on over-the-counter exchanges or "pink sheets," which do not offer investors the same level of legal protection.

Get Good Advice

While books, blogs and websites can all provide research material for investing in penny stocks, one of the best sources of knowledge on the market can come from investment clubs. These clubs are made up of both inexperienced and knowledgeable investors, some of whom invest in penny stocks. They can share their experiences in how to get started with penny stocks, which companies or industries are good bets and which warning signs you should look out for.

Talk to a Broker

Federal law requires that investors purchase their stock shares through a licensed broker-dealer. Brokers understand the market, including penny stocks. They can help you determine if penny stocks are the right investment option for your needs. They can also educate you on the process of investing in penny stocks, as well as the risks involved in participating in such a volatile market. Since brokers work on commission, you can talk to multiple brokers to shop around for commission rates, customer services and investment advice.

Know the Risks

The low investment price of penny stocks makes them among the most attractive and most volatile investments in the market. Before investing in specific penny stocks, you must understand the risks involved with the companies, their industries and the market as a whole. The Securities and Exchange Commission warns investors about the infrequent trading of many penny stocks, which might leave you without a buyer should you want to sell. You should also be aware of potential "pump and dump" schemes. These schemes involve a spokesperson who talks up the price of the stock, then sells out at the highest point. The leftover shares plummet in value, leaving investors with worthless shares.