What is a penny stock? Can they make you rich? Well, it worked for our guest Timothy Sykes who turned $12,000 into $4.2 million by trading them.
Timothy took his bar mitzvah money and started trading penny stocks against his parent’s wishes. What they warned him would be a hard lesson in the value of a dollar, turned into a small fortune.
What Is A Penny Stock?
Penny stocks are stocks sold by speculative companies for under $5 per share. Penny stocks are usually growing companies that have limited cash and resources or companies in dire financial trouble, often already in bankruptcy. As such, they are much riskier than traditional stocks. You don’t trade penny stocks with the intention of finding the next big thing, rather, you’re trading momentum. If you’re wrong about a pick, get out fast. This is not a buy and hold discipline.
When a “conventional” stock is down, over time, it’s likely to bounce back. That’s not the case with penny stocks. The companies often go out of business before a bounce back can happen.
You can make money betting against a company too. You take a negative position and sell first, then buy. If you see a stock that you think is over valued at $10 a share, you sell it and buy it back later at $2 a share. How do you sell a stock you don’t own? You borrow from your broker. You’re betting on failure.
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What Makes A Penny Stock Risky?
This all sounds good, take a small amount of money and turn it into millions through penny stocks. But nothing is that easy and the vast majority of penny stock traders lose money.
There isn’t much publicly available information on these companies and some of what you can find is from dodgy sources. Never risk disaster, don’t be sure of anything. Some of the companies are very young so there isn’t much information to be had. Many are in bankruptcy making it hard to find a fair valuation. The exchanges that these stocks are sold on do not have any minimum requirements to remain on the exchange. Because these stocks don’t have a lot of liquidity, you might not be able to sell them.
More Is Not Always Better
If you have $1000 to buy Apple stock with, that won’t get you much, currently less than ten shares. But if something is selling for .50 a share, you can snap up 2000. It seems more likely that your .50 cent stock will rise to $1 a share and you’ll double your money. But you have to consider the value, not just the price. The value is what someone else is willing to pay for something. In this case, part of the value of the stock is the value of the company. And a company selling shares so cheaply, is not doing well. It’s better to own part of a company that is making money than losing it.
Do Your Research
This kind of trading takes a lot of research. Timothy spends about 17 hours a day doing this. And as mentioned above, it isn’t easy because there sometimes isn’t much information to be had and what you find might not be accurate. Look for momentum, look for warning signs. Yahoo Finance is a good resource. The SEC website also contains a search engine where you can find all official filings made by a penny stock or any notices about an enforcement action from the SEC directed at any particular penny stock.
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You can use the lack of coverage for penny stocks to your advantage. CNBC and the Wall Street Journal aren’t following them. But you are and if you see some momentum, the company just got a big order for example, there is a lag between the time you see it and the time more casual observers see it.
Look for big movers based on a big earnings win or a big contract win. Look for signs of economic value gains. And cut your losses quickly. Take your ego out of it. If you made a bad call, get out fast and move on. You need a system in place and the discipline to stick to it. If you don’t have 17 hours a day to research and babysit the stocks you’re following waiting for something to happen, you can still trade penny stocks.
Timothy recommends concentrating on one sector and being attentive to the market between 9:30-10:30 and again between 3:00-4:00 because those are the hours in which most of the penny stocks move.
Cost Of Trades
When you’re expecting to make a gain of 20-30%, the cost of the commissions matters less. Timothy uses standard trading platforms like E-trade.
What To Look For
While conducting your research, there are a few key things to look for;
Volume– look for at least a few million shares traded daily and small bid/ask spread.
Balance Sheet -check how much cash the company has: more cash in the bank increases a company’s chances of survival.
Net Profit Margin -very low profit margins might mean that the company will soon start losing money.
Not Our Usual MO
Penny stocks are the opposite of LMM’s set it and forget it philosophy. They are risky and a lot of time and work. But they can be successful for small investors who are very meticulous. We bring this topic to you for educational purposes. If you plan to jump in, proceed with caution.
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Timothy Sykes: How to trade penny stocks.
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