A Primer on Penny Stocks

A Primer on Penny Stocks
by Phil Reich

If you have been considering whether or not to buy penny stocks, it would be advisable to do a reasonable amount of research before “jumping in with both feet”, so to speak. The world of penny stocks has often been glamorized by various investment advisory services as well as so-called “stock gurus”, but in reality you have to approach investing in penny stocks with a sober-minded attitude as well as a degree of caution and level-headedness. While it is true that extravagant profits can be made in the penny stock arena, it’s also true that there are more losers than winners, mainly because many people jump into the markets prematurely, blinded by the allure of quick wealth with a relatively small up-front investment. It would behoove any would-be penny stock investor to do his or her homework before committing their hard-earned money. That being said, hopefully this article will give you a better overall understanding of the penny stock arena and why they are a viable investment if used in the right manner.

What is a Penny Stock?

The most widely accepted definition of a penny stock is any publicly-traded company whose stock trades at $5.00 per share or less. Some have argued that the share price should be $1.00 or less to be considered a true penny stock, but for the purposes of keeping things simple, we will keep the $5.00-or-under definition. Most publicly-traded penny stocks are traded on the Over the Counter Bulletin Board Exchange (also known as OTC-BB), or on the “Pink Sheets” (somewhat of the “Wild West” of the stock market). These companies are usually valued as having less than $4 million in net tangible assets, and are normally companies that don’t have any type of extensive history. This would by default include many start-up companies and “one-man shows”. Penny stocks are also known as “micro-cap stocks” due to their relatively miniscule share value.

The Potential of Penny Stocks: The Power of Leverage

The power of a penny stock is the fact that the shares are normally priced so low that there is an incredible amount of leverage available to the investor that isn’t often seen in the “blue chip” stocks, such as Google, IBM, or FedEx. Think about it: The average “blue chip” company can trade in the neighborhood of hundreds of dollars per share, which means that the stock would have to make tremendous advances in order to double. Conversely, a penny stock that’s trading at literally pennies per share can double rather quickly, thereby doubling whatever initial investment you put into the purchase of those shares. As an example, it would be much easier for a stock trading at 10 cents per share to double to 20 cents per share (a 100), but the likelihood of the penny stock doubling is much higher than the “blue chip” ever doubling due to the hefty price per share of the “blue chip”.

Leverage is a Two-Edged Sword

Although there are some fantastic opportunities that exist in the penny stock arena due to the power of leverage, the potential for loss is also greater. A slight fluctuation in the price of a “blue chip” stock may only mean a 1 drop in your investment, while that same proportionate fluctuation in a penny stock is much more violent, generating potential losses of 50% or more. This volatility factor is the primary reason that penny stocks have often been labeled as “risky”.

Invest Wisely

The most reasonable way to approach a potential investment in a penny stock is to go into the trade knowing that you could possibly lose your entire investment. If you can live with yourself in light of that knowledge, then you may be ready to handle the ups and downs of the volatile world of penny stocks. If you’re not ready to completely part with your funds, and any loss of your initial capital would cause a major financial crisis, it would be advisable for you to stay out of the markets. The old adage is true, “Never risk more than you’re willing to lose”. This holds true especially in the arena of penny stock trading.

Phil Reich is actively involved in penny stock trading using the principles of technical analysis. He maintains a blog that teaches simple principles of how to buy penny stocks and sell them for a profit based on stock chart patterns.

Article Source: http://www.articlerich.com

Disclaimer(s) – Trading and investing involves a high degree of financial risk. There is risk of significant financial loss when investing and trading in stocks, futures, options, mutual funds, indices, index options, and other types of financial instruments including but not limited to foreign exchange (Forex) and currency trading. Investing and trading has large potential rewards, but also large potential risks. You must be aware of the risks and be willing to accept them in order to invest or trade in any financial markets. Don’t trade or invest with money you can’t afford to lose. Use risk capital only. Nothing on this website is either a solicitation nor an offer to Buy or Sell stocks, securities, futures, options, indices, mutual funds or any other types of financial instruments. No representations or implications are being made that any account will or is likely to achieve profits or losses similar to those shown. Past performances either actual or hypothetical of any trading system or methodology are not necessarily indicative of future results. The bottom line is that there are no guarantees in trading and investing – it involves financial risk. Leveraged instruments such as futures contracts and selling naked options, and other strategies and financial instruments may involve even a higher degree of financial risk than initially anticipated. Consult with your broker or a professional financial advisor before you invest or trade. Invest and trade at your own risk. You are solely responsible for your investing and trading decisions.

CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. NO FUTURES OR COMMODITY TRADING SYSTEM CAN GUARANTEE PROFITS. THE RISK OF LOSS EXISTS IN FUTURES TRADING.THE RISK OF FINANCIAL LOSS IS NOT LIMITED TO FUTURES TRADING, BUT ALSO INVOLVES ANY TRADING OR INVESTING IN OTHER FINANCIAL MARKETS SUCH AS STOCKS, STOCK OPTIONS, INDICES, INDEX OPTIONS. KNOW YOUR DEGREE OF RISK BEFORE INVESTING OR TRADING. ULTIMATELY, YOU ARE RESPONSIBLE FOR ANY AND ALL OF YOUR FINANCIAL DECISIONS.

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