Many excellent companies trade as penny stocks, and investing in those companies as they “grow up” to become bigger stocks can be extremely lucrative. Unfortunately, penny stocks have been given a bad name among the investment community, and in some cases that negative reputation is well deserved. But after you discover a few tactics for sidestepping the easily avoidable pitfalls in penny stocks, you can uncover incredible companies that will turn a small investment into a significant reward.

Protecting Yourself from Pitfalls in Penny Stocks

Investors who arent aware of the best ways to protect themselves from the risks of investing in penny stocks can sometimes get burned. But if you abide by the following pointers, youll be able to sidestep the vast majority of the low-quality investments, scams, and misleading information:

Avoid the lower caliber markets (Pink Sheets, OTC). Stick to penny stocks traded on the AMEX, OTC-BB, and Nasdaq.

Dont buy any stock based exclusively on a “tip” from a friend at work or family member. Always do your own research before investing in any stocks.

Never follow free stock picks! Whether you hear about the stock through a free newsletter, mailing list, or e-mail, keep in mind that free stock pickers have hidden motivations. They trick you into buying by using dishonest information and tactics, and dump the shares as soon as they mislead enough people to invest.

Only get involved with fundamentally solid penny stocks. You can quickly ascertain a companys quality through a simple online check of its financial position.

Dont fall for incredible stories in stocks. Some of the worst investments have an excellent “business concept,” such as a cure for a major disease, or an engine that runs on the power of gravity. Story stocks are usually terrible companies from a financial position, and the compelling nature of their business concept has pushed the shares well above any sensible valuation.

Call the investor relations contact at the company and ask a few questions. They will be happy to speak with you, and posing the right questions will enable you to ensure that the business is legitimate.

Crucial Criteria Found in Great Penny Stocks

When you find a penny stock that exhibits the following characteristics, you may have uncovered an investment that will grow in value for the coming months and years:

Growing market share in an expanding market.

The shares represent compelling value at current levels compared to other stocks in their peer group when based on financial valuation ratios, such as price-to-earnings or price-to-sales.

A management team that has had great successes with previous businesses.

Solid intellectual property (patents, trademarks, and copyrights) that ensures survival against the much bigger players in the space.