Many investors and traders often buy penny stocks for all of the wrong reasons which usually results in losing trades and diminished brokerage account balances. As is often the case, these reasons include buying on a hot tip from a friend or tout newsletter, new investors reading hype on financial message boards or buying stocks that are running on momentum which often leads to disaster.

Unfortunately, thousands of people with very little knowledge of market dynamics open online trading accounts each year, initially gravitating to the OTCBB or Pink Sheets stock exchanges attracted to the inexpensive pricing of the stocks that trade on these exchanges. Unwary, neophyte investors usually become disillusioned as their losing trades increase and their brokerage account balances decrease. These new market players are unaware that penny stocks should be reserved only for people that have the discretionary income and market experience to participate in this highly speculative investment arena.

Penny stocks are generally start up companies that are attempting to bring a product or service to market and are usually under capitalized and are dependant upon private investors and venture capitalist for seed money to execute their business plan. In order to acquire this seed money, penny stock companies often must give up part of the company in the form of either free trading or restricted shares in the company. This often results in more shares being issued and outstanding than the company initially desired.

However, the upside to penny stocks is that they can increase in value 1000 percent or more in a short amount of time which is the reason so many people are attracted to them. Successful penny stock investors know that finding companies with this potential are difficult to locate and understand that a dedication to research is the most important part of being profitable with these types of investments.