Is Trading Penny Stocks A Good Idea?
So, You’ve heard of the infamous penny stocks that lurk in the OTC (over-the-counter/pink sheets) stock market. I’m guessing you also heard that people have made millions trading penny stocks and that you can too… Maybe? I don’t want to be a buzz killer here but I would rather tell you the truth (based on my experience) about these mysterious and legendary type of stocks. My view on them is quite pessimistic. However, in this post, I will cover the good and bad, the advantages and disadvantages. By the way, the official definition of a penny stock is a stock trading at $5 dollars or lower. Now Let’s get into it.
The Truth Around Trading Penny Stocks:
I’m gonna make some assumptions about most of the people who will read this. Chances are you’re very new to the stock market and trading. Let’s be honest you’re in your first year of trading. Right? I probably guessed correctly. Why? Because trading penny stocks appeal mostly to beginners. This is because they are basically a get rich quick scheme targeted at beginners. Now there are some good and bad things about them and yes, you can make money trading them but there are some things to be aware of. Sorry If I broke your hopes on the matter but just know that I have experience on the subject. I know about these stocks and have traded them. You get the Idea… Let’s start with some positivity after this negative beginning to the post.
1. Huge gain/profit potential
This is the most common reason why people want to start trading penny stocks. While it’s true that if you have sufficient experience and skill, or, just get lucky, there are very large gains to be made. 20, 50, 100+ Percent gains are not uncommon. Pretty Crazy, I know, but don’t get too excited.
2. No need for much capital
One of the big challenges of a beginner trader is that he or she probably has low capital. Therefore, the big moves found in penny stocks are attractive and seem like an easy ticket to growing your trading account. This is usually just an illusion as big moves can also be found in bigger, Nasdaq stocks for example. However, there is some truth to the point that you can make good money with low capital with penny stocks. If you’re able to catch the enormous moves of course.
This can be both good and bad depending on various factors. I will explain this point further in “The Bad:” Section of this article.
1. Penny Stocks are very risky
The fact of the matter is that penny stocks involve a huge amount of risk. You could literally lose the whole or majority of your investment. Not Fun. Actually, based on statistics, more than 90% of penny stocks will go to zero and basically die. Trust me, I have seen it happen many times.
2. Low liquidity
For the most part, Penny stocks trade in very low volume. Except on rare occasion when the stock is “hot”. This is bad because of the volatility it creates (explained below). It also can make it hard or almost impossible to exit positions because there are no buyers. The last thing you want is to be left holding the bag…
3. Extreme volatility
Partly due to the low volume traded on these stocks, the price moves found in penny stocks can be extremely sharp. Both to the upside and downside. This means that if you’re not prepared you’re toast!
This goes hand in hand with volatility. Penny stocks can fluctuate very quickly with large changes in share price. So, if you don’t know technical analysis and have no experience day trading you will probably get destroyed in the OTC markets.
5. Uneven playing field
The arena that penny stocks are in is not beginner friendly contrary to popular belief. When you’re trading these low priced stocks you’re competing against: stock promoters/pump&dumpers/manipulators, experienced traders, false news, fake companies… Yeah, it gets pretty wild out there. Just in case you don’t know what a pump and dump is, click here.
To conclude, yes, you can make money, even a lot of it, by trading penny stocks. But, unless you have the high technical and general knowledge about the stock market that you need you’re going to fail with these stocks miserably. Many people have blown up their accounts by trading penny stocks so be really careful. I would say, that the OTC markets are for experienced and prepared traders only. Even then, you’re probably better of with big, brand-name stocks. Anyways, whatever you do, I wish you the best of luck. If you do end up trading penny stocks and it goes bad you will at least have gained knowledge. You will be a better trader if you learn from your mistakes. It’s the only way to truly learn in this game.