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Trading Penny Stocks - Step by Step

For some reason, people just can’t seem to avoid the lure of penny stocks. Everyone dreams of turning $100 into $100,000,000. It doesn’t happen, no matter how often you hear the hype. But it is like telling a teenager not to have sex. The head will go up and down and they will do it anyway, no matter the risk.

So, since you are going to do it anyway, I might as well tell you how to do it the right way. Hopefully I can help you avoid most of the risk and keep you from losing too much money. I will show you using the Big G, since everyone is familiar with it. For some parts, I will use my own website for analysis because it is much simpler and clearer than anything else I have seen. That’s why I spent 10 years developing it. You could use other financial sites, but they are sometimes too complex for Joe Sixpack or Mary Brownbag to use.

Please understand that the penny stock world is, for the most part, unregulated. That means that it is also filled with sham companies set up for no other purpose than to take your money. They will open and close overnight. Fortunately, most of these are easy to avoid if you know what to look for.

How to Find Penny Stocks

Do a quick search for the term “Penny Stocks” and you will find hundreds or even thousands of newsletters, videos and advisories promoting penny stocks. That is how most people promoting penny stocks make their money – income from newsletters, not trading. They can recommend any old piece of crap (usually something they are trying to dump) and if you lose your money, well it’s your fault, isn’t it? You didn’t time it right. You sold at the wrong time, yadda, yadda, yadda.

So never use anyone else's newsletter or recommendations. Use your own brain and skills. If you haven't the experience yet, bank your money until you have learned as much as you need to feel comfortable trading. Since I know you are going to ignore this advice also, please do this:

Before buying any stock, do your homework. The mistake most people make is thinking that penny stocks are different from other stocks. They are not. You still need to be as sure as you can that you are investing wisely. It is much better to buy 100 shares of a good company than 100,000 shares of a dog.

I always recommend buying only quality stocks. Use any investing strategy from the Will The Geek website and you will find a number of penny stocks, those trading at less than $5. They are usually noted as Nano Cap or Micro Cap. They may be cheap stocks, but at least they meet the criteria for quality stocks: They are profitable, they are (usually) growing, they are in growing sectors and they are fairly liquid. That is, there is enough trading volume so you can exit your position when you want.

It is true that many penny stocks, mostly those trading below $1.00 are shams, but not always. That is exactly how I found American Airlines, among others. Here are some pointers that will help you tell the difference:

This one is cheap, quick and simple. Let’s say that you know the ticker for the company you want to trade. Go to Google Finance and put that ticker in the search box. When the chart comes up, click on the 10 year display where you see the red arrow. You will see something that looks like this:

Now look at the highest point that appears on the chart. That is the highest the stock ever sold for. In this case, the high was around 70 cents and that was 10 years ago! The chance of it ever going back enough to make any money on is extremely small.

Now look at the volume – the blue arrow. If the volume isn’t at least 10,000 per day average, you won’t be able to get out when you want to sell. No one will be willing to buy your shares. Also, the average daily trade volume should be at least 10 times the number of shares you plan on buying.

So far, our sample is looking pretty bad for trading but let’s continues anyway. Look at the left side of the screen. You will see the list called Company Summary. Look for the “Financials” item (red arrow).

If it is not there don’t bother with the company. If they don't have financials, they are a death trap. Find something else.

If they have the financials, click on the link and look to see that the latest financial data is for the current quarter or maybe the previous quarter.

This is December, so you should see either June or September. If the data is older than that, do not bother with the company. They are not filing their documents with the government on time or maybe not at all.

How to screen for Penny Stocks

All that assumes that you know the company name or ticker. If not, you will need to find a list of known high quality stocks regardless of price. From this list, you can do some research on which company best suits you and your trading style. If you are not sure where to start, go to my website and look for undervalued stocks. Those are among the best companies available. We are going to use the F-Score strategy since it is the most powerful and profitable. Here is a link: F-Score. You will need to be registered with an email address to see it, but there is no charge or anything (at least for now).

The site is not aimed at penny stocks, but almost all trading strategies will contain some. You will at least have some confidence that they meet the criteria for quality, even though they may not be as good as some of the others you will find. At the risk of repeating myself, you should really just look for the best quality stocks you can find and not pay too much attention to price. Personally, I love trading the small caps and micro caps. They have the best returns without the risk of penny stocks.

OK, so once you have logged in, select Strategies/Premium/F-Score. You will be given a list of highly rated and undervalued companies. There will most likely be some below $5 (and sometimes below $1). There usually are. But don't just pick a stock because it is cheap. Always look for quality first.

If you want to see only penny stocks, when you get to the page, about half way down you will see a set of dropdown lists. In the first one, uncheck any boxes that may be set. Now select Nano Cap and/or Micro Cap as you see here:

Now click the Refresh Data button. You will now see a whole list of penny stocks.

Penny Stock Analysis

Here is a 5 second course of identifying a quality company. It sounds complicated at first, but once you have done it a few times it is literally that quick.

In the left column of the list you get from the F-Score, is a Select link. Clicking that will give you a detail page for the company. Ignore the top two charts for now and look at the third row. You should see something like this:

This is the quarterly chart for Mobileye NV. I am not telling you to buy it. It is only an example.

The yellow columns are the sales or revenue. You want at least 5 quarters (8 is best) of increases as you see here:

The green is profit. Same here, you want at least 5 quarters of increasing profit.

The red column is cash. Same again. Constantly increasing cash in the bank tells you they know how to use their money.

Purple columns is debt. You don't see any here because the company has no long term debt. That is Great! No debt means more profit.

For a company that does have some debt, it should be declining. The chart should look like this:

That's about it for now. No rocket science needed. It is quick and simple. If your target company gets through all that, it is time to take the next step.

The Homework

Once you have found a good candidate you will need to do a little more investigation before giving up your hard-earned cash. For this you will need to go to the public sources. Let’s go back to G/Finance or to Yahoo! Finance.

Enter your ticker symbol in the search bar. From the screen you get, scroll down until you find a description of the company. On Google, it is about half way down.

Ask yourself these questions:

  • What do they do?
  • Is it a product or service that everyone can use or will benefit everyone? (Shows large potential for growth)
  • Is it in a growth sector? (New or growing technology, new geographic area and so on)

Next we want to look at the news. You will find it here:

Now look for these clues:

  • Are analysts increasing their forecasts?
  • Is there any news of mergers or acquisitions?
  • New patents?
  • Insider buying activity, especially new institutional investing? Good. Insider selling? Bad
  • Any other good news?

If the company passes all of these tests, you most likely have a winner. As you know, there are no guarantees in this business. So much depends not only on how, when and what you buy, but when you sell. That will have to wait for another lesson. For now, practice what you have learned here. Paper trade, study and read everything you can. Track your progress. Keep score on yourself until you can pick stocks with confidence.

To recap, be cautious. Reduce your risk as much as possible. Money is hard to gain and easy to lose. Don't be a sucker and just guess or listen to any idiot who thinks he knows the stock market, including me. Do your homework. Cut loses quickly but let a winner run.


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