Penny Stocks For Dummies. Peter Leeds

interests based on their online activity. And just as you may expect, data from top sources indicates that people’s interest in penny stocks is on the rise.

      The term “penny stocks” is one of the most popular financial queries on the major search engines, topping such phrases as “stock pick,” “stock quote,” “New York Stock Exchange,” “NYSE,” and “stockbroker.” Such searches represent millions of people worldwide actively looking for tips or guidance about low-priced shares, and that broad-based interest is growing.

      I offer some reasons for the increasing interest in penny stocks in the following sections.

      A high risk/reward ratio

      You’ve heard the old adage, “the higher the risk, the higher the reward.” This saying is especially apt when it comes to penny stocks. Investing in speculative shares is always very risky.

      However, you can dramatically reduce your risk in penny stocks – while maintaining your higher reward potential – by abiding by the various concepts I detail in this book.

      I’ve personally lost $15,000 on a penny stock (risk), but I have also turned $30,000 into $500,000 (reward). After having traded all types of investments, from real estate to options and from currencies to derivatives, I’ve never found a more lucrative or reliable method for building wealth than buying fundamentally solid penny stocks.

      The risk-reward ratio increases as you move down the list of these investment vehicles:

      ❯❯ Hiding money under your mattress: Barring a house fire, you won’t lose your principal with this savings strategy, but you won’t gain anything, either. Of course, even cash stuffed in your pillow will lose its purchasing power due to the effect of inflation.

      ❯❯ Certificates of Deposit (CDs): These investment vehicles have very low risk, but you get paid very minimally because they’re so secure. An investment of $100 may be worth only $102 a year later.

      ❯❯ Bonds: Government or corporate bonds expose you to minimal risk but have very low payouts. If you invest in bonds issued by riskier countries or companies, you can make a little more, but also increase the possibility of losing your money.

      ❯❯ Real estate: Property ownership has generally been profitable over time in most areas. However, the risk-reward ratio depends greatly on the area and your timing. Florida condo ownership was very profitable for a long time – until home prices collapsed and many people lost their shirts. Real estate investments also entail significant carrying costs (property tax, insurance, condo fees), and when you sell you face numerous disposition fees (real estate agent commissions, land transfer tax).

      ❯❯ Blue-chip stocks: Big name companies are generally considered to be safe investments, but they can drop in value and very often do. Although blue chips generally provide better returns than CDs or bonds, they can also go down in price, and so the potential for greater returns comes hand in hand with increased risk.

      ❯❯ Midrange and small cap stocks: These investment vehicles are riskier than blue-chip stocks and safer than penny stocks, making them a good option for people who aren’t quite ready to trade very small, highly speculative companies associated with the tiniest of shares.

      ❯❯ Penny stocks: Penny stocks offer the perfect mix of risk and reward for many individuals. You can push the odds of making money strongly in your favor by using the techniques I describe in this book. Plus, penny stocks are easier to understand than complex strategies required for options trading and they have the potential for bigger returns from smaller investments, when compared to other investment types.

      ❯❯ Options and derivatives: These extremely risky investment vehicles are only appropriate for complex hedging strategies. If you don’t understand what I mean by “complex hedging strategies,” then you shouldn’t trade options.

      I’ve made money from each of these investment vehicles and I’ve also lost money from most of them. If you seek absolute safety for each dollar you invest, then penny stocks aren’t appropriate for you. However, if you are willing to assume risk in the hopes of creating some more money from your portfolio, you’ve come to the right place.

      Limited funds

      Of the many reasons why an individual may be attracted to penny stocks, the most popular is that the investor has limited funds. Whether you have only a few hundred, or a couple thousand, dollars to invest, low-priced shares afford you an opportunity to turn that small amount of cash into something much more substantial.

      

Investors with small amounts of start-up cash also tend to be more interested in taking a shot at something, almost like they’re buying a lottery ticket, partially because they feel that they don’t have a lot to lose. This is precisely the wrong approach, especially if you have limited funds.

      I always suggest that investors with limited funds, or even those with no funds at all, start off by paper trading, as I detail in Chapter 5. Only after you discover how to find penny stocks of great fundamental quality, and to trade them well, should you venture into using your limited amount of real money.

      Risky misconceptions

      

Unfortunately, traders are prone to a number of misconceptions about penny stocks, many of which can expose them to unnecessary risk:

      ❯❯ They can’t fall much lower. If a stock falls to pennies from several dollars or more, some investors wrongly believe that the shares can’t go much lower. Don’t make the mistake of comparing any stock to where it was before, because the stock has no memory, and past levels have no bearing as to where it may go from here. For example, even a stock that fell 99 percent – from $5 to 5¢ – can go a lot lower, and might just be on its way to 0.

      ❯❯ It’s not a big investment. If you invest $500 in a stock rather than $5,000, you’re risking less money (or, to use investment lingo, your downside is limited to $500). But the size of your downside has no bearing on whether the underlying shares are a good investment. If your reasoning is that you didn’t invest a lot, you’re gambling. If you buy a stock because it has an outstanding management team, low debt load, and expanding market share, you’re investing.

      ❯❯ The downside is smaller than on blue-chip stocks. Just because penny stocks are closer to zero than large blue-chip stocks or more expensive shares, it doesn’t mean that they are less risky. A $455 stock can go to 0. A 4¢-penny stock can go to 0. In either case, you can lose 100 percent of your investment.

      

My aim in addressing these risky assumptions is to help you approach penny stocks in the most knowledgeable, and therefore most profitable, way. Every dollar put into the market is at risk, and by being fully aware of that risk, you are in a better position to make wise trading choices.

Taking Stock of the Big Business of Penny Stocks

      Small businesses are the source of the majority of economic growth in the United States, and this is probably true in most nations worldwide. In addition, the small-business sector is America’s largest employer.

      When small businesses need to raise capital, they often go public by listing stock on the market (I describe this process in Chapter 3). Some of these companies are tiny, or just getting started, and their value is still low, so they often trade as penny stocks. As such, penny stocks are a big part of the economy.

      In addition to making significant contributions to the economy, some penny stock companies eventually grow up and become huge corporations with hundreds of employees and share prices of $10 or $50 or more. Most people don’t realize that many corporations that used to be penny stocks helped build the economy from the bottom.

      You’re not alone

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