Penny stocks, which typically trade outside of the major market, are defined as stocks that trade for $5 or less. Though you can make a profit trading penny stocks, you could also lose a lot of money very quickly. Penny stocks are high-risk due to their speculative nature; not much information is available to the public, and the companies are often brand-new or about to go bankrupt.

If you intend to trade penny stocks, the best thing you can do is prepare by doing your research and understanding the market. Here are our top tips for finding and trading penny stocks.

1. Understand the Risk
Before you buy any penny stocks, it is important to understand how risky it is to trade them. Unlike stocks for companies that are traded on the major markets, penny stocks are not backed by well-established companies, nor are they required to maintain the set minimum standards to stay listed on the OTCBB (Over-the-Counter Bulletin Board) or pink sheets.

While penny stocks start at low costs, you can still lose a lot of money. According to Investopedia, many penny stocks listed have no value or are scams. To find the best penny stocks and minimize your risks takes substantial research time. While some penny stock companies eventually grow large enough to be traded on the secure market, many will fail before they get that chance.

Before you buy any penny stocks, make sure that you can afford to lose money and will not end up bankrupt or in debt due to some bad trades.

2. Research the Companies
When you find a stock that you are interested in, it is up to you to thoroughly research the company and the market it is in to determine if it has potential for growth. Since penny stocks are largely sold on unregulated exchanges, you'll need to find much of the information yourself.

You can turn to a trusted source for information, like a reputable newsletter or trading group. You could also turn to a financial advisor about trading penny stocks, but, depending on your financial situation, many will recommend that you do not buy penny stocks.

Before you sign up for a newsletter or a group, make sure to research it and see where its money is coming from. Some newsletters are scams that act as a front for penny stocks. They recommend a specific penny stock in exchange for payment and do not research whether or not that penny stock is actually a worthwhile, valid investment.

If you cannot find any data on a company or stock, do not buy it. Put your time and investment money only toward stock that you can verify.

3. Find a Comprehensive Stock Screener
A good stock screener should have a lot of filters for you to use. These filters let you narrow your selection based on price, trading lows and highs for a set time period, trading volume, and other criteria. A stock screener takes out some of the guesswork during your hunt for the best penny stock for your investments.

4. Sell Quickly
Penny stocks rarely make good long-term investments. Again, very few penny stocks mature to a point where they are sold on the major markets. Rather than buying penny stocks with the hope of them becoming the next big thing on the market, sell your penny stocks when you can make a profit of 20 to 30 percent. These incremental growths quickly add up. Take profits when they are readily available, and do not get caught in the trap of waiting for astronomical returns on your penny stock.

5. Cut Your Losses
As with all stock trading, there is a risk of loss when trading penny stocks. However, unlike in more stable markets, it is not wise to wait for a penny stock to bounce back, since many of these companies are brand-new or already in financial trouble. When a penny stock takes a steep downturn, sell it quickly. If you keep waiting for it to turn a profit, you could end up losing your entire investment.

6. Ignore the Hype
While newsletters can point you in the right direction, you should never take advice from anyone without doing your research. Before you buy the latest stock that your newsletter or financial advisor recommends, make sure to do your own checkup on the company. Many penny stocks are unreliable. While there are no guarantees, a little extra research could save you money in the long run.

Investing is risky, no matter what path you take. Never invest money that you do not have and cannot afford to lose. However, with education and careful steps forward, penny stock investments can help you earn a profit. Follow the tips above, and most importantly, make sure to do your own research to limit the chances of buying scam stock.

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