Your co-worker has been bragging all day about his 1000% return on a stocks investment. Then you hear about your golf buddy who made millions of dollars investing in small caps. You get curious. They narrate how they invested in a few hundred penny stocks and then sold them when the prices moved up. Does it sound easy and enticing? Make sure you know where to put your money before penny stocks leave you penniless.

What are these penny stocks?

As its name suggests, penny stocks are shares sold in pennies. Some consider penny stocks as any stock priced less than $5. Penny stocks can also be defined as stocks with a market capitalization of less than $500 million.

Where can you search for penny stocks?

Penny stocks can be found on over-the-counter (OTC) markets. OTC trading refers to stock trading done outside of the major stock exchanges such as the New York Stock Exchange, NASDAQ, or AMEX. Companies offering penny stocks are listed in the Over-The-Counter Bulletin Board (OTCBB) and the Pink Sheets.

Who offers penny stocks?

Startup companies that do not want to file an initial public offering (IPO) on a major exchange may opt to start trading on the OTCBB as a penny stock. Companies that have been booted out, or delisted, from a major stock exchange also conduct trading over-the-counter.

Choosing your broker

If you have decided that you want to dip into the stocks investment pool, the first thing you should do is hire a broker. Stocks investment brokers maintain a database of penny stocks being traded on the OTCBBs and the Pink Sheets. When choosing a stocks investment broker, pick someone you can trust and work comfortably with. In addition, make sure he/she is registered with the SEC and has a license to operate in your area.

Choosing which companies to invest in

As with any other purchase you make, the key to successful stocks investment is due diligence. Know whom you are entrusting your money to and where it will be spent. The OTCBB requires companies to file annual and quarterly audited statements, so you more or less have an idea of a company's financial success. Note that the Pink Sheets does not.

Available information is usually biased and inaccurate, so it's all up to you to dig into the company you are investing into.

When choosing penny stocks, always check a company's history. Who are the people that own the company? If it is losing money, find out why. If the company has been involved in financial scandals, bank frauds, money laundering, corruption, scams, and organized crime, news websites should have picked it up and published a detailed report.

Be wary of stocks investment newsletters that include company profiles. There should be a disclaimer stating the amount or number of shares the newsletter is getting for featuring a particular company. Keep in mind that if the information source is being paid, the author will always try to make the company look better than it actually is.

Deciding how much to invest

There are hundreds of thousands of penny stocks. If you are new to stocks investment, start your position in the $2000 - $3000 range. This way you can keep your losses to a minimum if a stock price plummets by 50% or more. If your stocks have done well, either take your profits off the table, or add to your position.

Investing on penny stocks can be lucrative, but make sure you do your homework and protect your capital.