Want to learn how to research penny stocks without relying on others for advice? Understanding a few basics will be enough to quickly analyze a penny stock. It might seem intimidating at first but trust me, it’s not difficult. Don’t be the person who throws money into any idea that sounds promising and later discover it’s a pump and dump.
Penny stocks appeal mainly to retail traders and who can blame them? The potential for large gains is mouth watering and blue chip stocks are boring – especially if you’re only trading with a few thousand dollars.
Below I breakdown the steps needed to do research:
1. Find Penny Stocks to Trade
Since there are thousands of penny stocks it can be tricky to decide where to start. Pro traders typically use premium stock screeners like Trade Ideas to find penny stocks based on certain criteria – top gainers, biggest losers, stocks gapping up or insider buying etc.
There are free screeners available at StockFetcher.com and Finviz.com, they’re more limited but great for beginners.
Below is a list of stocks I generated using Finviz.com with simple filters. I was looking for stocks under $5, market cap of $50-$300 million, average volume above 100,000 and shares outstanding under 20 million.
Outside of scanners, researching emerging trends/industries on Google is a good place to start. For example when the crypto market is heating up, start searching for blockchain or NFT related penny stocks. To give you some inspiration, the type of industries I’m currently researching are Uranium, Artificial Intelligence, 5G and eCommerce. Based on the trend, I filter for stocks that could benefit from the growth of the industry and do a deep dive in the business. Be cautious of penny stocks trying to jump on trends that are not related to their core business!
2. Beware of Dilution
Share structure is one of the first things I review when analyzing a stock. Penny stocks tend to be heavily diluted because they need to keep issuing shares to raise money. The more outstanding shares available, the more volume needed to move the stock price. If you want the stock price to increase, more buying power will be required. There are penny stocks with hundreds of millions, even billion shares available. Generally, I prefer stocks with under 50 million shares. You can view the share structure on Yahoo Finance. For example GNUS has 300 million shares outstanding.
3. Review Financials
If you’re day trading penny stocks, the financials might not interest you but it’s worth taking a glimpse at them. I like to see revenue, net income and cash flow improving year-on-year and quarter-on-quarter. The financials don’t have to be perfect but everything should be trending in the right direction and the debt load isn’t a burden. I also like to compare the financials against the nearest competitors to make sure the valuation is realistic.
Important Financial Ratios
- Price to Sales
- Current Ratio
- Operating Cash Flow
- Inventory Turnover
- Debt Ratio
4. Find a Catalyst
The penny stocks you discovered most likely lured you in by a potential catalyst. Catalysts aren’t hard to find and “trading gurus” regularly pump them after the fact. It’s important to note, these narcissists only care about their own interests, not yours. Don’t chase stocks after the catalyst is over as penny stocks dump quickly. They take the stairs up and the elevator down!
Ok enough fluff, let’s cover the main type of catalysts.
Strong Expected Earnings
Sometimes traders have reason to believe a penny stock will report strong earnings. Find out the date a company will release earnings report well in advance and beware of any recent news. Typically penny stocks will spike before earnings and when earnings are released there’ll be a slight dip.
Penny stocks typically lose money but when they become profitable, their share price should spike. Going from losing money to turning a profit is a key milestone and can be a good time to buy. This information is available in the quarterly or annual earnings report. You can view the most recent cash flows and debt changes for a company on Yahoo Finance.
FDA approval is the godfather of all catalysts for biotech penny stocks, causing huge upward movements. These can be risky trades as you’ll need to buy before it’s 100% confirmed to profit. You can learn about upcoming FDA filings from websites such as Biopharm Catalyst and FDA calendar.
Patent Filing and Approval
When a patent is filed or approved it tends to get a lot of media attention. Patents can be filed in any country but patent approval in the United States is big news if the patent is significant. For the latest patent news, visit the U.S. Patent Office website.
If a CEO or Director starts purchasing a large quantity of shares, it’s a positive signal for the future. CEO’s are not allowed to trade based on insider information but let’s face it, some do. To find penny stocks with insider buying, visit insidertracking.com to get the inside scoop.
Companies forming new strategic partnerships are worth following. Generally, a partnership means joining forces with another business to help deliver a product or service. It might make more sense financially for a company to outsource an aspect of their business, example Coca Cola outsourcing their packing and bottling. For penny stocks, the vast majority of partnerships are overhyped and are only announced in press releases to pump the stock.
5. Perform Technical Analysis
Technical analysis involves studying historical chart patterns to predict the future direction of a stock price. It’s important to know, technical analysis isn’t useful when a stock is thinly traded or is part of a pump and dump scheme. Generally, the greater the trading volume, the more reliable chart patterns become.
Five basic technical analysis terms you should learn:
- Support Levels
- Resistance Levels
- Moving Averages
- RSI (Relative Strength Index)
- MACD (Moving Average Convergence Divergence)
Below is a video from Peter Leeds, explaining the basics of candlestick charts, chart patterns and the top technical indicators to follow.