Investing

Penny Stocks 101: Benefits And Risks Associated With Buying Cheap Shares

Investors with no exposure to the stock market were watching many people get rich very quickly off penny stocks in 2020 and 2021. GameStop is one of the few stocks that comes to mind as it experienced astronomical growth in a short period of time.

Naturally, public interest in buying and selling stocks, especially penny stocks, has increased in recent months. Fortunately, there will always be new opportunities for investors to take advantage of penny stock growth.

This balanced penny stocks guide by Tim Sykes makes it abundantly clear that buying and selling penny stocks is very risky. Within the first paragraph, he notes that many penny stocks are companies “in danger of going out of business.” But at the same time, the opportunities to profit are legitimate for anyone with the proper mindset.

Who Is Tim Sykes?

Tim Sykes is a millionaire penny stock trader with decades of experience. He became famous in the internet universe for turning his $12,415 Bar Mitzvah present into more than $6 million by trading penny stocks.

Today he focuses mostly on penny stock education (and many philanthropic endeavors) with a focus on differentiating himself from the other educators. Sykes makes it perfectly clear that trading penny stocks is far from a get-quick rich scheme.

He emphasizes many times over that making a lot of money from penny stocks is a long-term journey made possible through small wins over a long period of time.

Source: Timothysykes.com

What Are Penny Stocks?

Unlike what the name suggests, penny stocks refer to shares of a company that trades below $5. Some of these companies are very new with unproven technology and little sales. In fact, it is possible for a penny stock company to exist without a product to sell to the public. Think of a biotechnology company developing therapeutics that is years away from regulatory approval.

And then there are penny stock companies that are weeks or days away from bankruptcy while others are engaged in outright fraudulent behavior.

With that said, one would be forgiven for thinking it is foolish to trade or invest in penny stocks. But within the penny stock universe, there are many reputable companies worthy of an investor’s attention for either a long-term holding or short-term trade.

The Short-Term Penny Stock Trading Mentality

Buying and selling penny stocks for the short-term avoids the stressful uncertainty of what lies next.

Penny stocks are extremely volatile as days worth of gains can be wiped out in a few minutes. So the logical strategy is to simply bank profits whenever and wherever they come, especially small ones.

As Sykes alludes to, investors need to approach penny stock investing with a mindset of aiming for singles and doubles. Investors aiming for home runs and grand slams are more likely to end up striking out.

Sykes writes: “Know in your heart most of these companies won’t succeed… But that they could experience some huge spikes before they fade into oblivion.”

Taking many small profits has to be accompanied by a similar strategy of taking small losses. As soon as a trade goes in the wrong direction it is important to call it quits and move on to the next trade. After all, a small $50 loss in the penny stock universe can very quickly snowball into a $200 loss.

The Long-Term Penny Stock Investing Guide

Sykes is a short-term penny stock trader but the extraordinarily strong stock market action after the first quarter of 2020 and very early 2021 resulted in many penny stock winners. Taking a look at some of the winners and the sectors they belong to will give investors an idea of how to be on the lookout for the next potential large winner moving forward.

Take Novavax, Inc. (NASDAQ: NVAX) as an example. The biotechnology company that generates next-generation vaccines for serious infectious diseases entered 2020 trading below $4 a share.

It goes without saying that investor demand for companies with direct exposure to a potential COVID-19 cure increased. But savvy investors paying close attention felt bullish in their decision to buy Novavax when the company said on Jan. 21 it started developing a vaccine candidate.

The stock ended 2020 at around $111 but shares approximately tripled in the first few weeks of 2021 after a Phase 3 trial in the United Kingdom found its vaccine candidate was 89.3% effective against the virus.

FuelCell Energy Inc (NASDAQ: FCEL) is another example of a penny stock company with exposure to a hot segment at the right time. FuelCell is a sustainable clean energy technology company that saw its shares skyrocket from $1 in 2020 to as high as $29.44.

As it became more clear the world is shifting towards clean energy sources, companies like FuelCell convinced investors it is in a position to satisfy the demand for alternative and green energy sources.

And then there is the GameStop Corp. (NYSE: GME) saga fueled by Reddit traders motivated in part by forcing hedge funds to cover their short positions at massive losses. There was no particular logic behind the stock’s insane rally from under $3 a share to near $500 in a matter of days. In this case, wise and risk-conscious investors got out before the stock came crashing down just as hard as it went up.

Bottom Line: Remember What Penny Stocks Are

Penny stocks are for the most part unstable companies but the very low price attracts lots of investors. Many think they will strike gold and find the next mega-winning trade. As noted above, some will indeed do exactly that.

On the other hand, even savvy investors will think they found a fantastic company only to be proven wrong.

Bottom line, penny stock trading and investing can be extremely risky and should be reserved exclusively for investors that understand the importance of proper risk management. There is no reason why 5% to 10% of a balanced and diversified portfolio can’t be exposed to penny stocks.

Even in this scenario, a penny stock investor can lose 100% on their picks and still end the year with gains coming from the other 90% to 95% of the portfolio.

A post by Kidal D. (5016 Posts)

Kidal D. is author at LeraBlog. The author's views are entirely their own and may not reflect the views and opinions of LeraBlog staff.

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