Should You Invest In Penny Stocks?

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Penny stocks are stocks of small companies, typically trading for less than $5.  These stocks can be appealing to the novice investor starting with little to no money because of the cheap price and ease of access.  This quick blog will touch on a few reasons we don’t recommend investing small and we don’t recommend investing in penny stocks.

Not a path to quick riches

People look at penny stocks as a way to turn a little into a lot.  The odds just aren’t in your favor for multiple reasons.  If you are starting with a little, even if you win big, you still win small.  For example, that $20 investment that went up 300% is now worth $80.  You cant even buy a pair of sneakers for that.

Additionally, aside from winning small when you win big, the bigger problem is that a 300% return doesn’t exist.  I have never seen it.  It is not likely, and if your investment strategy hinges on big wins like that you are setting yourself up to be disappointed.  Your best case scenario is a situation that likely will never even occur.

The next thing is that the commission will eat up your gains. Say you invest $20 in Scottrade, that is now $13 after the $7 in commission, your gain on the “300% return” is now $52.  Then you have to deduct commission on the way out, $45.  Even in the best of situations, trading small and in pennies is just not wise.

Susceptible to Fraud 

Because penny stocks trade off the major stock exchanges (NYSE, NASDAQ) they can be manipulated so that big runs lead to big gains for the people pushing up the run.  Our office got the opportunity to invest in the stock of a Korean electronic motor company.  Upon doing some research we learned that the person pushing the stock had no connections to the company and the company had no idea what we were talking about.  This guy was looking to use our company for headlines and then sell the stock at the top.

If you have ever been given a hot tip via post card or email this was someone attempting to pump up and promote demand so they can then sell that stock to you who thinks it will go higher, while they cash out on your money.  You have to protect your cash.  Don’t be desperate and don’t be so money hungry that you become prey to the big dogs in the game.  Pigs get slaughtered.

The big runs you see in some stocks are often fake.  In the end you lose because you weren’t hip to the fact that the early money would be bailing.  It wasn’t the economics that propped up the company, it was the artificial demand.

They are cheap for a reason

One of the biggest things to take away from this post should be that penny stocks are cheap for a reason.  Often times these companies don’t have any sales, no assets, and no growth prospects.  Basically the fundamentals of these stocks are trash hence the cheap price.

If you went to the grocery store and saw brown bananas on sale for pennies would you buy them thinking that they will turn yellow again? Don’t don’t this with your investments either.  Pick the quality watermelon that needs time to ripe or the avocado that needs time to soften.  That is how you invest.  Investing is like picking fruit. (Idea for next blog).

Often times never come back 

The sad fact is that often times penny stocks are on their death bed. These are companies that at one time may have been great but are on their last leg heading to zero.  Don’t be the person who buys thinking they will get taken over. Don’t be the person who buys thinking they will one day make a run.  Its possible but not probable.

Investing is about playing the odds.  You want to pick companies that give you the best odds of winning despite the potential downside. If this means you need to wait and save so you can make a bigger play, wait.  I was in your shoes trading hundreds in pennies hoping for a pop.  Don’t waste your time.

Another option is to join our investment club.  We allow people just like you to tap into a large scale fund for as little as $25. We would love to have you.  To join, email info@capitaltodd.com

Be great, invest well,

Todd Millionaire

 

 

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