Those that invest in penny stocks are going to find this to be one of the more risky adventures in investing that they take on. The good news is, though, that there are plenty of great opportunities out there to do really, really well with penny stocks as well.

So, how to make sure that when you invest in penny stocks that your stocks go the right way for you?

This is a trick question because, like all investing, there is no sure fire way to make millions of dollars off of just one dollar. Everything has a risk involved with it and that risk is a common factor in why many people avoid the penny stock investing game. Why?

Penny stocks are quite beneficial when they turn out. But, because you are blindly putting your money into a no name company, you may find yourself losing it all the same. Many investors look towards other, more conservative types of investing instead for that very reason: they could lose it all this way.

Yet, you will learn throughout your investment career what you need to do in order to find success with penny stock investing. The secrets here come from having a solid knowledge base about what penny stock investing really is as well as what it can do for you if you play the game correctly.

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Wait until the stock is back to where you bought it, and you may be waiting for a long time. As well, this philosophy sometimes makes investors sell at break-even when the stock is moving past the buy price and into even higher territory.

Averaging Death - Er… I Mean Averaging Down
Averaging down is when you buy more shares of a stock after it has sunk. This makes your average price per share lower. For example, you bought 1000 shares at $2.00, the stock sinks to $1.00 and you buy 1000 more. Now you have 2000 shares of stock at an average price of $1.50. This can be beneficial as the price only needs to increase 50% now to get back to break even, rather than 100%.
However, be warned. Averaging down is just throwing good money after bad, and very rarely works out to the advantage of the investor. You already expected the stock to go up, and it went down. Now you are doubling your position in a stock that is not performing as you would like. Your fresh money may be better spent going into an entirely new stock altogether, as then you can pick from a pool of thousands, rather than putting more cash into a sinking ship.

Danger - Thin Ice
Well, you might say the stock can’t sink forever and eventually it has to rebound. This is the main argument that people use to justify their methodology of buying more shares.
However, there are some factors that you may not have considered which can really hurt a stock price without being very visible. For example, often a wounded stock will consolodate shares (commonly referred to as a reverse split). All of the sudden the stock price doubles but you have half the shares. This gives the underlying stock room to continue its decent from a higher platform. Usually after a reverse split shares do decline in value in the short term.

Another problem would be if the company is in real trouble. The shares could keep sinking until $0.00. This is the only ‘guaranteed’ price bottom you’ll ever find, and if anyone tells you different they are not being forthright. In such a case averaging down is a really bad idea.

When Is Averaging Down Effective?
After considering what we have said above, there are exceptions for averaging down. Perhaps the company is solid, with earnings and improving revenues. Maybe the stock price has simply been decreasing in sympathy to the overall market, or along with its sector.
If you feel strongly about the company, from an educated rather than emotional standpoint, then averaging down can be effective. That is, of course, if you are right about the company.

Quick Fixes and Professional Tips
You must never ‘fall in love’ with a stock, or be emotionally attached. You need to be able to logically examine your holdings with an unforgiving eye. When a stock starts going down, or acting differently than you expected have the courage to say “I was wrong,” and cut it lose. The money from that investment could certainly do better for you in an entirely different stock. As well, professional traders very rarely take loses of more than 15%. Once the stock starts to sink past their maximum loss limit, they sell immediately, no matter how much they like the company.
Don’t sink all of your cash into a stock at first. It is often good to buy half or a third of what you can afford, then give the stock some time to perform. If the shares increase you’ve made some money. If they sink, you have money held back to average down (as long as the company is strong and is simply being undervalued).

Many professional traders ‘Average Up’ which is buying more shares only if the price begins to rise. The increasing shares prove that they were right to pick the stock and gives them confidence in their research methods. If the company is in a long term uptrend they’ll be making plenty of money on the shares, especially since they increased their exposure.

Revenues
This is how much money the company is making. Many penny stocks may not have revenues at all if they are in the development stage, or if they are trying to bring a brand new product to market. However, if the company has been around a while they had better have enough revenues to offset some of the costs.
If the company is in its growth stages, there has to be an increasing trend in revenues. If they are trying to gain market share, or break into new markets, their success should be tempered with improving revenues.

Earnings
Of course, revenues are just a precursor to earnings. All companies want to eventually make money, and it is when they start bringing in more revenues than costs that all the magic happens. Positive earnings can have an excellent effect on penny stock companies, because they are suddenly on their way to becoming something more.
If a penny stock is not heavily funded from external sources, or they don’t have a significant cash position, they need positive earnings to stay afloat, fund ongoing operations, and take advantage of their intended strategic options.

Debt
Some companies can get saddled by enormous debt, especially in their start-up or early growth phases. This can be detrimental in many ways, as interest payments can cut into earnings, and creditors can pull strings at inopportune times, effectively sweeping the feet out from under a fragile company. There are also issues of control, and dependence.
Until a company’s revenues out-pace expenses, debt will continue to grow. Unless, of course, the company raises capital through other means such as dilutive stock offerings, or by giving up significant control to venture capitalists.

Assets
All of the cash, inventories, and property of a company have some value, and can give you a quick glimpse of the health and position of a company. For example, if they have six million in cash, with yearly costs of one million, you could assume that they would be able to meet their operational requirements for a long time.
If they had significant miscellaneous assets, they may be able to sell these off to raise capital if they needed. However, if their assets are well below their liabilities, the company will likely need to find a quick source of financing to meet their obligations.

Liabilities
Here is how much the company owes or needs to pay out. The lower the value the better, especially when compared to assets. There should almost never be higher liabilities than assets. In fact a ratio of 1:2 is standard in some sectors, to give a company some breathing room.

The Bare Bones
Without at least this basic understanding, it is unlikely that you have enough information on the stock you are interested in. Sure, its great to jump on board a stock with a good story, but if you dig a little deeper you may find that the company actually has a great story, or has some underlying problems that the average investor may not know about.

by Peter Leeds