Learn four risk factors and four rewards you face when you invest in tech penny stocks

Buying any penny stock can lead to a big payday when you make the right choice. But the odds against success are high. Penny stocks are almost always involved in riskier ventures, such as finding mineral deposits that can be mined at a profit, commercializing unproven technologies or launching new software.

There’s a delicate balance between risk and reward with tech penny stocks, but fast-changing technology can offer huge opportunities in these stocks.

Tech penny stocks may start out with a promising business plan, but they need all sorts of things to prosper in the long run.

Companies must have the right employees, adequate financing, the right merger partner, a favourable economic and regulatory climate, and favourable competitive situations and research outcomes.

Four risk factors you face when you invest in tech penny stocks:

Penny stocks have appeal for some aggressive investors who aim to get into fast-growing stocks at what they describe as “the ground floor.” They think the best way to profit in stocks is to buy them when they are just barely starting out on a growth phase that can last for years if not decades. Ideally, they want to buy the future top performers when they are still near or close to the penny stock range and have yet to be discovered by the broad mass of investors.

1. Marketing is as hard as inventing: Even a great new product or computer programs may fail to overcome the scepticism of retailers and consumers.
2. Acquisitions can bring “time-bomb” risk: Companies sometimes grow quickly by buying other companies. But it may also be the case that those selling the companies may simply want to bail out of a losing situation.
3. Major tech penny stocks also make mistakes: Tech penny stocks often trumpet their deals with major firms, such as Apple or IBM. And it’s true that Apple and IBM have much more knowledge and bargaining clout than any individual investor. But they still invest in products that fail.
4. High-tech shams are common: It’s easier to set up a company and sell stock to investors than to perfect a technological breakthrough. Be especially wary when tech penny stocks splurge on elaborate websites and glossy investor brochures.

Four ways to increase your rewards with tech penny stocks:

It may seem contradictory to use the terms “investment quality” and “penny stocks” in the same sentence. However, there are even wider disparities in the investment quality of penny stocks than in better-established companies. That’s because, while it’s hard for any new company to grow into a profitable business, it’s even harder in pioneering fields, where most penny stocks operate.

With tech penny stocks, there are methods and tips to gain greater returns from your investments:

1. Diversify: The high-tech sector has more than its share of winners and duds. So invest carefully and buy 5 to 10 tech penny stocks instead of just one. Gains on your winners should overwhelm any losses you have.
2. Focus on up-and-coming technologies: To do this, you need to know how technology is changing. For instance, the immense popularity of wireless devices, like the iPhone and tablet computers, stepped up demand for faster, more reliable wireless networks.
3. Buy multi-product companies: Technological advances come in spurts, and they leapfrog each other. Focus on tech penny stocks that have some existing or soon-to-be-released products, and avoid one-hit wonders.
4. Look for earnings: A perpetual money loser will eventually go broke, no matter how impressive its technology. But if it makes even a little money, it can stay in business and perhaps reap the bonanza of a new product.

What’s one key factor you look for when considering tech penny stocks? Tell us in the comments!

Note: This article was originally published in 2012 and has been updated.