What Are Penny Stocks?
When many people think of penny stocks, they think of some fly-by-night company with shares of stocks that trade for fractions of a penny. While there are companies out there like that, we concern ourselves with only upstanding companies. In this case, a "penny stock" is any company's stock that trades for less than $5.00 per share. Many of these stocks trade on NASDAQ, as well as the New York and American Stock Exchanges. There are literally thousands of fine companies that have a share price under $5.00 per share. In fact, Microsoft was a $5.00 stock at one time!
There is an unfortunate belief among many people that doing well in the stock market (and other markets, for that matter) requires a great deal of work and loads of time. This is partly a function of those in the markets wanting to make what they do seem complicated, and therefore exclusive. The reality of the situation is that you do not need to dedicate your life to the markets to produce good results.
Invest within your Means. Penny stocks are as risky as larger stocks if not traded wisely. Set aside sufficient savings to last three months in case the investment goes wrong.
Understand why penny stocks are considered a dangerous investment.Penny stocks are among the most volatile and most manipulated form of investment in the stock market. The companies usually have no track record of solid financial performance.[3] In addition, the stocks are often manipulated by scam artists.[3][4]
Get at least one year's experience with mid- and large-cap stocks first. You should become adept at reading a balance sheet, income statement, and cash flow statement during this time.[1]
Learn more about the specific aspects of penny stocks that make them both potentially lucrative and dangerous to your portfolio. Understand the mechanics behind money flow, market capitalization, and share structure. Also understand the purpose of a public company and the commonality of scams, dilution, and loss of investment value associated with penny stocks.
Know which stocks to reject off the bat:[1]
- stocks that aren't traded on one of the major U.S. exchanges (aka bulletin board or over-the-counter [OTC] stocks)
- companies that have less than $10 million in revenue annually
- any company recommended in e-mails about penny stock trading (promoters are often paid to create hype so that the shares will sell)
- companies in industries that you don't like or understand well (based on your experience)
Instead of share prices, compare price per share against book value per share (assets minus liabilities).[2]
Buying penny stocks isn't as easy as signing in to your discount stock broker and placing an order. It's a lot more work than that!
Generally the only place to buy penny stocks is through the over the counter market (OTCBB) or the Pink Sheets. Your regular discount broker may not allow you to buy and sell penny stocks without signing a special agreement, if at all. You may even have to place a phone call and agree that, yes, you really know what you're doing and you accept the additional risk that you could lose your entire investment and you really do understand what you're doing when you're trading penny stocks.
Can you make money by trading penny stocks? Sure, people do it all the time. People also lose money trading penny stocks. That's why you occasionally see spam for and scams involving penny stocks—investors buy low, then try to drive up demand into a frenzy and sell their own shares at the height of the frenzy. If that sounds like fraud, it is.
What does that have to do with value investing? Absolutely nothing.
Ignore penny-stock success stories
Timothy Sykes, a penny-stock expert who trades both long and short, says you must not believe the penny-stock stories that are touted in emails and on social media websites.
“You have to say no,” Sykes said. “You can’t invest in penny stocks as if they were lotto tickets, but unfortunately that’s what most people do, and they lose again and again. Think of penny stocks as inmates in a prison that you can’t trust.”
Instead, Sykes says, focus on the profitable penny stocks with solid earnings growth and which are making 52-week highs.
One allure of penny stocks is you can make 20% or 30% in a few days. If you make that kind of return with a penny stock, sell quickly
