Timothy Sykes has helped make trading penny stocks more popular, and even introduces people to the idea that you can short penny stocks (especially during a pump and dump). This is a nice thought, but it’s very difficult to find stock in order to short and the fees are usually sky high. For the purposes of this post, I will be talking about going long on a penny stock.
You should avoid investing in penny stocks because….
There’s no profit. Most companies behind penny stocks have no profits at all. I’ve even seen companies with absolutely no sales! If you’re into fundamental analysis, which you should be, you want to see low debt, nice cash flow, increasing earnings, and so on. Penny stocks usually have nothing to analyze.
You lose from the start. With penny stocks, the bid/ask spread is just way too much. Let’s say a stock is offered at $0.25 and bid at $0.20. You take on a 25% loss as soon as your trade goes through. And that’s if you have no commissions or fees!
They’re easily manipulated. Commonly referred to as a “pump and dump” scam, it’s when insiders hype up a stock and sell their own shares during the price spike. Penny stock promoters rely on your gullibility, believing there’s a quick fortune to be made. Even if you catch a “pump and dump”, you might have trouble getting out of the trade.
Napoleon Hill warned us that we shouldn’t seek something for nothing, but with penny stocks, there’s a pretty strong temptation to throw your hat in the ring. However, I would recommend staying away from penny stocks. You shouldn’t invest with money you can’t afford to lose, but when you go with penny stocks, you should almost expect to lose.
Of course, I’m speaking statistically. The majority of people simply don’t have the time and/or energy to learn proper trading strategy, protection mechanisms or asset management. In a sense, the markets simply funnel money from the uninformed to the informed.
If you want to err on the safe side, stay away from microcaps and penny stocks. They have too many problems, and for every cockroach you can spot crawling across the floor, I promise you there’s ten more in the walls. A pretty scary metaphor, but losing money is scary.