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Why Buy a Penny Stock Index Fund?

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I’ve had a few questions come up lately regarding penny stock indexes versus individual stocks and why a trader would choose one over the other. Good question, but first for our beginners’ benefit, let’s define what a penny stocks index actually is. A penny stock index, like other indexes, is an investment vehicle comprised of stocks in the correct proportions that make up a particular section of a stock market, in this case micro-caps.

How to Buy Penny Stock Index Funds

You can’t actually go out and buy the penny stock index, unless you’re willing to buy each and every stock comprising it, a ludicrous idea in itself. Instead however you can buy what are called index funds which are investment vehicles that closely track a specific index. Though there are some actively managed penny stock funds out there I prefer a penny stock ETF (Exchange Traded Fund). The main difference between an actively managed mutual fund and an ETF is that with an ETF, the fund company is merely trying to replicate the index which translates to much lower management fees and less risk since you’re not relying on a particular money manager’s expertise. Of course some may argue that if the manager is particularly good at selecting penny stocks you can do far better with managed funds but again, be aware then that you’re hedging your bets on a single money manager versus the overall index. To each his own.

Now as mentioned in my other articles, a penny stock can be defined in a number of ways so you shouldn’t be surprised that fund company’s definitions of micro cap stocks vary as well. Some define them as any stock below a certain market cap (e.g. $300 million) while others simply take a set number of stocks from the index such as the bottom 1000 stocks by market cap and call them micro-caps. Regardless of how they’re defined however there a number of excellent low fee micro-cap funds worth considering.

Best Penny Stock Index Fund

One of the most popular, and best penny stock index funds as far as I’m concerned, is the iShares Russell Microcap Index Fund (NYSE: IWC). This index fund is based on the bottom 3% of the US stock market and the main reason I like this fund is its high liquidity and volatility, allowing you to easily day trade it, swing trade it, or even invest in it for the long term. Some of the other microcap funds worth mentioning include the Vanguard Small-Cap ETF (AMEX: VB), the PowerShares Zacks Micro-Cap ETF (NYSE: PZI), and the iShares Morningstar Small Core ETF (NYSE: JKJ).

The great thing about these penny stock ETFs is that like all other ETFs, they trade like regular stocks and can be bought and sold easily within your discount brokerage account. As such, they can also be shorted as a hedge or even bought on margin (though I wouldn’t suggest this unless you truly are a trading professional).

Benefits of Index Funds

So why buy a penny stock fund rather than a group of handpicked penny stocks? Well, it really depends on what you are trying to achieve in your investment portfolio. If you’re looking for aggressive growth but just can’t stomach the risks of individual penny stocks, a penny stock index fund might just be the investment vehicle you need. Though they will certainly not achieve the same level of gains a high potential penny stock pick can yield, they do provide higher growth potential than your average index fund or even blue chip stocks. Another big advantage is that you no longer have to worry about the large amount of risk associated with individual small cap companies since in essence you are well diversified, investing in hundreds of stocks through one investment unit.

Drawbacks of Index funds

The main downside of a penny stock fund however is that, well it’s a fund and no matter how well the fund performs, it can never achieve the same results a few good penny stocks can yield. In other words you’ll never see a fund gain 50% in one day, let alone 1000%, which can definitely happen with the right penny stock.

So in a nutshell, though a penny stock index can make an excellent addition to your portfolio and be used for certain investment strategies, if you’re in the market to make significant returns in a relatively short period of time, there really is no substitute for trading penny stocks. If you do go down the path of individual stocks however, you have to recognize the extra risk you’re taking on and thus should do everything in your power to help mitigate that risk. Use stop losses, limit penny stocks to a small percentage of your stock portfolio, never invest more than 5% of your equity in any one stock, consult a reputable financial advisor, and above all never use money you can’t afford to lose.

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4 Common Strategies For Day Trading Penny Stocks

Out of all the various trading strategies out there, day trading penny stocks is probably one of the most profitable and risky.  In simple terms, day trading penny stock involves buying and selling a stock within one trading day.  In other words, you would start and end the day holding only cash with no open stock positions.  Intra-day trading is inherently risky yet when done correctly can also be extremely profitable.  Like all things, especially in the world of investing, the higher the risk the higher potential reward.

There are essentially three main attributes to look for in a penny stock trading candidate:

High Liquidity
If you’re going to be day trading a penny stock, you better be sure it is highly liquid, meaning it trades throughout the day with high volume.  Without high volume, the spread between the bid and ask price can be so wide, you won’t be able buy penny stocks at a competitive price and even if you manage to buy some stock and can easily get stuck with shares you simply can’t sell before the end of the trading day.

High Volatility
We’re often taught by investing experts to avoid highly volatile stocks but when you day trade penny stocks, this is exactly the type of stock you want.  Stocks that have wide daily trading ranges offer better opportunities for profits compared to those that trade flat.

High Quality
When day trading penny stocks, don’t trade junk.  Remember, you will be buying these stocks and holding them for a period of time, however short that might be.  As such, there’s always a chance you may be left holding shares after the close so you better pick stocks you wouldn’t mind holding to the next trading day.  There are gutsy traders that will trade just about any stock but I say why bother; there’s plenty of quality companies out there you can profit from, so why take on even more risk than you need to?

Once a few good penny stocks have been short listed, when trading penny stocks there are some basic strategies traders will typically use to help minimize risks and maximize gains:

Scalping is probably one of the more popular strategies due to its simplicity.  With scalp trading you are essentially taking advantage of market inefficiencies with respect to the spread.  The gap between the bid and ask price (i.e. the spread) can narrow and widen rapidly throughout the day creating buying and selling opportunities for quick profits.  In order to scalp successfully, you’ll need access to Real Time Level II Quotes which is normally available from most penny stock brokerages.

Range Trading
With all other things being equal, stocks will often trade in a set trading range throughout the day.  With range trading your goal is to buy at the bottom of that range and sell near the top (or vice versa when shorting).  If implementing this strategy, look for stocks that appear to have a fairly consistent trading range from day to day.

Momentum or Trend Trading
Have you ever heard the phrase “the trend is your friend”?  Well, with trading penny stocks, identifying trends through technical analysis and buying and selling according to that trend, can prove to be very profitable. In basic terms, with trend trading, you buy a stock when it is trending up and sell as soon as it reverses that trend or conversely when shorting the stock you short sell it when trending down and cover your position at the point it starts to recover.

Real-time News Trading
Another common strategy used by traders is to buy penny stocks the moment good news is released and sell after the punch up or short the stock on negative news and buy back after the news has settled. This type of trading can be achieved through the use of a real-time news feed.

The rewards from online penny stock trading can be very great yet the stark reality is most penny stock day traders end up being unsuccessful so regardless of what strategy you decide to use, always try to limit your risk by using stop loss orders and never risk more than you can afford to lose.  In addition, day trading penny stocks should be limited to a small portion of your overall portfolio.

The Risks and Rewards of Pink Sheets Penny Stocks

With an interest in buying penny stocks, you almost certainly would have heard the term “pink sheets” or just “pinks” at least once.  The term “pink sheets” actually comes from the color of paper the stock quotes were originally printed on but now it refers to the electronic quotation system used for a variety of OTC securities.

Pink sheets penny stocks are essentially stocks with a price below $5.00 that trade on the Pink Sheets electronic quotation service. But what exactly is the pink sheets and how does it differ from the OTCBB and major markets like the NASDAQ and NYSE?

An important point to note about the pink sheets is that it is not a registered stock exchange but a computerized quotation system and the stocks that are listed on the pink sheets are generally stocks that could not meet the specific requirements of a major stock exchange.  Furthermore, unlike stock exchanges the pink sheets are not regulated by the Securities and Exchange Commission (SEC).  As such there are virtually no requirements for historical or even current financial data though companies issuing stock on the Pink Sheets are at least bound by both federal and state security laws.

Obviously due to the lack of regulation, the pink sheets can be a dangerous place to buy penny stocks.  Therefore, you really need to perform your due diligence on any potential company your interested buying stock in.  Companies can vanish with out a trace from the pink sheets along with your hard earned cash.  Due to these factors in addition to the extreme volatility and unpredictability of pink sheets penny stocks, it’s highly recommended that an investor stick to trading with money he can afford to lose and no more than 10% of of his portfolio.

Having said all this, by exercising both caution and experience and by implementing specific stock strategies, a lot of money can be made in the pink sheets.  Why?  Simply, pink sheets stocks can double or triple in price very easily.  A 5 cent share for example can quite easily become a 10 cent or 25 cent share in a matter of weeks,  leaving a 100% or 400% gain respectfully.   Seeing that the average stock goes up a measly 6% per year, it’s very easy to see the lure of penny stock investing.

Whether you decide to buy penny stocks on the pink sheets or on the OTCBB, by being very selective in the stocks you choose in addition to using various proven stock strategies to limit your risk, this portion of your overall portfolio can very easily become your most profitable one.

Why the Attraction of Canadian Penny Stocks is Growing

If you’re wanting to profit from penny stocks, you might want to look beyond the US borders (assuming that is where you live) and more specifically pay attention to Canada.  A lot of investors who specialize in micro cap stocks love Canadian penny stocks and for good reason.

Canadian penny stocks and Canadian stocks in general have performed extremely well the past several years compared to the rest of the world.  Canada, like the US is a very stable democratic country with low risk for political or economic instability.  However, Canada is also extremely rich in natural resources including oil and precious metals which have all been skyrocketing in recent years along with the stocks related to these commodities.  Canadian gold penny stocks and oil penny stocks in particular have done very well and made a lot of penny stock investors small penny stock fortunes!

With that said, how do you get your hands on Canadian penny stocks?  In a nutshell, Canadian penny stocks can be found in five different markets:  the pink sheets, OTCBB, the Toronto Stock Exchange, the TSX Venture Exchange, and to a lesser degree, the Montreal Exchange.   The pink sheets and OTCBB are US markets and trade in USD.  The other three are all Canadian stock markets and thus trade in Canadian currencies.  The Toronto Stock Exchange is by far the largest and most reputable Canadian stock exchange with the strictest regulations.  The Venture Exchange however is probably where you’ll find the most penny stocks and in particular, precious metal penny stocks.

Now that you know a bit about what markets Canadian penny stocks trade in, you really have two main options as far as how to actually buy them.  The first option is to open a Canadian brokerage account whether it be a discount brokerage or full service brokerage.  Some popular Canadian discount brokerage companies include Scotia itrade (formally E*trade Canada), Interactive Brokers, RBC Direct Investing, and CIBC Investor’s Edge.  Full service brokerage firms include BMO Nesbitt Burns, RBC Dominion Securities, and Laurentian Bank Securities.  The second option is to open a US brokerage account that allows trades in Canadian equities or to simply buy Canadian penny stocks via the pink sheets or OTCBB markets.  The OTCBB especially often has the USD equivalent version of a Canadian penny stock that can be purchased in US funds.

No matter which option you choose, buying Canadian penny stocks is not difficult and the rewards can be great.  Just make sure you always peform adequate penny stock analysis  and research on each company just like you would before buying any stock investment.