Looking for penny stock trading indicators that will boost your odds of success? Here are the key ones to watch for

Buying low-quality penny stocks is one of those things that can appear to be successful before it goes badly wrong. Some investors get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than high-quality stocks.

Here are some penny stock trading indicators that can help improve your odds of finding the best of these risky investments.

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Penny stock trading indicators and the quality of your investments

The Successful Investor approach revolves around choosing high-quality investments and diversifying your holdings. Our three-pronged Successful Investor program takes that general description a little further. In addition to spreading your investment money out across most if not all of the five economic sectors, we advise you to invest mainly in well-established companies, and focus on companies that are outside the broker/media limelight.

While they can from time to time soar quickly, Canadian penny stocks are quick to fall just as fast when a bubble bursts. For instance, two decades ago, buyers of Internet start-ups made far more profit than investors who stuck with well-established companies. The same thing happened when many investors bought low-quality resource stocks in 2007 and 2008, and it has happened in the past in penny stock bubbles. When the bubble bursts, however, prices of low-quality stocks inevitably come crashing down. After all, it’s much easier to launch a stock promotion than it is to create a successful, lasting business.

Penny stock trading indicators: Start by recognizing that penny stocks are often marketing campaigns in disguise

Penny stocks do sometimes pay off, but there are many pitfalls to avoid. You should be aware that many penny stocks are little more than very well-executed marketing campaigns.

Lots of penny stock promoters will do anything in their power to get their penny stock noticed. These extensive marketing campaigns include emails, TV interviews, podcasts and self-produced promotional newsletters.

Not all penny stocks and their promoters are out to cheat investors. But it’s important to approach any penny stock with a very healthy dose of skepticism.

Penny stock trading indicators: Understand that claims of major company involvement may be distorted

Penny stock promoters love to make deals, however small or indirect, with major household-name companies. They’re sure the public is far more likely to buy penny stocks that have agreements with large well-established clients. The penny stock hopes that the link with a major brand will give them instant credibility, even if it far from guarantees any sales or profits.

For example, a mining penny-stock may promote that Newmont Corp., BHP Group or another major mining company has decided to finance the exploration of their mining claims.

However, when promoters manage to make a deal with a major firm, they often go to great lengths to make it seem bigger than it is. Instead of announcing that the big company has invested, say, just $50,000, a stock promoter may issue a press release saying the two companies have entered into a “multi-stage development plan.”

The release may say the major company has agreed to spend “up to $10 million” or some other exalted figure.

Above all, remember that big companies have far more bargaining power than individual investors.

A big company doesn’t go into a situation like this the same way you do. If the big company agrees to spend $50,000 to study the mining property, new technology or pioneering program, it will also insist on a series of options that let it invest ever-larger sums on favourable terms. But the big company will always reserve the right to drop out and cut its losses. In most cases, it will exercise that right.

Do not be fooled by predictions of success with penny stocks

Predictions never work out as well as hard facts.

You see this again and again in investing. For example, stock market predictions are terrible at determining what actual changes will take place in an industry. It’s even harder to predict how long those changes will take to appear. Of course, adverse changes are hardest on companies with bad financing, poor products, weak management or other drawbacks. Meanwhile, successful companies figure out ways to adapt and even profit from change.

Most successful investors agree that it’s a good idea to base investment decisions on facts rather than stock market predictions. You can make mistakes with facts, of course, but predictions have a much higher failure rate.

What indicators do you look at to determine if a penny stock is a good buy?