The Pros and Cons of Trading Penny Stocks

Posted by SimpleTrades on May 09, 2013 (08:57PM)

"Trading penny stocks is different than trading blue chip stocks. Just like with any other securities before you trade penny stocks you should learn about the risk they involve. Trading penny stocks has advantages and some disadvantages compared to blue chip stocks.

First let’s look at the disadvantages:"

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Posted by doougle on May 10, 2013 (09:47AM)

Cons:  Don't choose your stock based on how many shares you can own.

Posted by incubus on May 10, 2013 (02:56PM)

Simple, be careful.

Think of penny stocks as a movie audition.

500 people might audition for the parts, of them, maybe a dozen are cast in the movie, and of them, maybe one becomes a star.

Any website or individual that tells you they have "secret" or "inside information" is lying for their own agenda or engaging in insider trading.

No insider trader is going to advertise their doing something illegal....think of these sources as agents for the auditioners, each agent wants his client to be the next star, but very few make it, the agents will tell you anyone's a star as long as it's their client.

If you're looking at chart patterns to gauge a penny stock, see my first point, the odds are gravely stacked against you....a "double bottom" for an OTC or PINK stock is more likely meandering it's way down than up.



Posted by SimpleTrades on May 10, 2013 (08:37PM)

As I mentioned you have to be good stock picker. There are also penny stocks that trade above their 200-day SMA and MACD is on the positive side. You just have to be careful how you screen for these stocks. Maybe you just one to pick some and follow them for a couple of weeks or month without investing real money. You can also try paper trading penny stocks to see if it works for you.

Posted by IncomeAddict on May 10, 2013 (08:59PM)


What's good about penny stocks - they are a penny

What's bad about penny stocks - just about everything else


  ............................................................ Sorry, I just couldn't resist     : )

Posted by incubus on May 10, 2013 (10:56PM)

SimpleTrades said: As I mentioned you have to be good stock picker. ...

 Rule of thumb, that would eliminate penny stocks altogether.

This is why fund managers can't buy stocks below $5, the stats on microcaps are dismal, even worse for sub $1 penny stocks, professionals aren't allowed to put customers money into that much risk....why would you?

SimpleTrades said:  There are also penny stocks that trade above their 200-day SMA and MACD is on the positive side. ...

Many micro-caps stay range bound for years, but again, substantially more range upward in other asset classes & cap sizes.

If you want more vol or beta with better odds, why not look in the RUT2000, SP600, SP400, N100, mat'ls, tech, semi's, energy or commodities?

Each of them has a pretty high beta, but much less risk than pennies.

SimpleTrades said:... You just have to be careful how you screen for these stocks. Maybe you just one to pick some and follow them for a couple of weeks or month without investing real money. You can also try paper trading penny stocks to see if it works for you.

 My suggestion, screen as large a basket you can of the best possible penny stocks you can find, using whatever parameters you use.

Track them as a whole for several months, paper trade them as you would if you owned them & account for all fees....use Google finance's portfolio tool, it will accurately track your results and cash balance - you only need to enter transaction details.

Then compare your results to the SPX and major indices over the same time.

.I suspect you'll find it more difficult than you figured, if you were able to beat benchmark, it likely took a lot of work setting stop losses & screening for new stocks & setups and it's highly probable you'd have done better sitting on an index ETF.

If you can pull it off, I'll be impressed...and I'll want your secret/.



Posted by Bullogic on May 11, 2013 (09:10AM)

incubus said:

SimpleTrades said: As I mentioned you have to be good stock picker. ...

 Rule of thumb, that would eliminate penny stocks altogether.

This is why fund managers can't buy stocks below $5, the stats on microcaps are dismal, even worse for sub $1 penny stocks, professionals aren't allowed to put customers money into that much risk....why would you?


 While some mutual funds have clauses that don't allow their managers to invest in sub $5 it is not a regulation nor a requirement.

Posted by incubus on May 11, 2013 (01:04PM)

Bullogic said:

 While some mutual funds have clauses that don't allow their managers to invest in sub $5 it is not a regulation nor a requirement.

 Didn't say it was, however, it is against the law for municipal, state or federal pension fund managers.

None of the big banks allow it, no large funds allow it for their individual managers, unless that's the specified target of the individual manager.(very unusual)

With that kind of buying power not on the side of sub-$5 stocks, it fortifies my point on the stats/probabilities for them.

Bad idea unless you know firsthand the company has a solid business model and it's about the break the $5 mark. again,bringing me back to the insider trading dilemma.

Posted by brdrok on May 12, 2013 (01:16PM)

Uhmm....my feeling is that there is a reason why they are Penny Stocks to begin with.  


As incubus said, you REALLY have to know the business/financials of the the Penny Stock company.

Posted by SimpleTrades on May 12, 2013 (06:44PM)

By definition Rite Aid is a penny stock. Here is what they say about it:

"After Rite Aid (RAD) posted a quarterly profit in December, and I have been heavily invested in the company ever since, starting at $1.20. Since then, the company has posted its first year of profit in more than six years and is guiding for significant bottom-line improvements in 2013. While I have expected a broader pullback after the stock reached $2.68, it now looks as if investors are buying at $2.50, not letting it fall below that point. The stock is now slowly but surely starting to reverse, and I think it will soon retest highs of $2.68 and break into a higher level over $3.00.

There are many people who might think I am crazy for "expecting" a six-month 300% gain in shares of Rite Aid, but the truth is that those people don't know the RAD story or how far it has come. Nor do they realize that RAD would still be far cheaper than its larger competitors. The stock was pushed lower for years due to inefficiency, but now -- thanks to the patent cliff in biotechnology -- prescription volumes and margins are significantly higher. Rite Aid is a massive company, it has but a 0.47% profit margin but produced net income of $107.47 million last year.

Its two larger competitors have an average profit margin of 3.10%, thus allowing much room for improvement. Furthermore, Rite Aid trades at just 0.09 times sales, significantly cheaper than the 0.60 times sales seen by the two industry leaders. Therefore, a $3.00 price target is not unreasonable. In my opinion, a $5.00 price target isn't unreasonable, as Rite Aid would still be trading at a deep discount to its peers. Thus, with the company now seeing a bottom at $2.50, I would watch it closely for a rapid turnaround and the continuation of its uptrend."

Posted by incubus on May 12, 2013 (07:45PM)


Simple, RAD might make a decent compliment to the "lottery ticket", speculative portion of a portfolio.

There are always outliers, the point is that penny stocks overall have a substantial uphill battle to the $5 mark, big buyers won't touch most stocks until 
that point,.like my "audition" metaphor, most stocks below $5 fail to pass muster.

You may be onto something maybe they'll be bought out like PALM was, or maybe they've altered their business model to compete.

If you know something about RAD that the mainstream is missing, then it could be a good value bet, but from where I sit, it looks like they once won the $5 mark, then lost it.

I only know that they're in competition with Walgreens and CVS, and glancing at the chart over the years, it looks like RAD has gradually been losing the game.

I might suggest comparing it's price range between 2002 to 2007 to the 2009 to present period, this company has already won and then lost the struggle to get over $5.

Posted by SimpleTrades on May 12, 2013 (08:36PM)

Incubus, the chart below compares RAD and the two other stocks you mentioned since 2009. RAD has been a good "lottery ticket" since 2009.

Posted by incubus on May 12, 2013 (09:34PM)

SimpleTrades said: Incubus, the chart below compares RAD and the two other stocks you mentioned since 2009. RAD has been a good "lottery ticket" since 2009.

 
Absolutely, now here's the same chart going back to 2000- 




Posted by incubus on May 12, 2013 (09:39PM)

And, for good measure, over the life of the stock -

Posted by spshapiro on May 12, 2013 (11:05PM)

ST, If you bought RAD  back in early 2007, you paid over $6 and within less than two years, your stock was worth less than a quarter. Still today, it pays you no dividend to wait for things to get better. So basically, it’s the stock version of shooting craps. If you owned WAG over that time period, you got a dividend of over 2% and worst haircut was 50%.  Granted just about everything took a haircut 2007-8, but now WAG is well above the old high water mark. I will grant that WAG is highly unlikely to double from here, but it is also highly unlikely to be cut in half. If you don’t understand, that’s why ‘penny stocks’ are a pejorative to many of us. No one is saying that you stand no chance of winning with these plays, just that the chance of losing is higher than some of us are willing to take.

If you say that these time frames don’t matter to you, because you only see them as short term trades, then we are coming at this quite differently. I have far too much at risk in the market to be risking the majority of it on the throw of the dice. In fact to risk just a little of it on the throw of the dice, wouldn’t make a lot of difference to the total, but would require me to be in a wholly different frame of mind about investing. Even then, why would I wish to take a greater risk for a reward that has less of a chance of succeeding, and if it should succeed wouldn’t make a great deal of difference to the total portfolio.

Posted by SimpleTrades on May 12, 2013 (11:22PM)

Spshapiro, I added Microsoft to your chart. MSFT is not a penny stock, right?

Posted by SimpleTrades on May 12, 2013 (11:28PM)

To make it more interesting I added HPQ and DELL:

Posted by spshapiro on May 12, 2013 (11:47PM)

The point isn’t whether we can find a golden nugget among the pennies, or a turkey among the large cap tech stocks, but whether you are more or less likely to find a good one looking in one direction or the other. Every year or so, someone drafts a football player from a division III school go goes to the Pro Bowl within five years, but do the clubs spend the bulk of their efforts looking in this direction, or at the big name schools?  BTW, MSFT pays you 2.8% to wait, has less variability, and you can sell covered calls for quite some time before they are assigned.

All that I ask is that you recognize the extra risk you are taking with your mode of investing, not that you change. I’m not saying that what you are doing is nefarious, although some who push pennies are merely doing a pump and dump. I recognize that there are many legitimate companies that dwell in this realm. Some of them grow quite well, but many don’t. I prefer to lengthen the odds where ever possible, so that they favor me. Selfish SOB that I am.

Posted by incubus on May 13, 2013 (12:45AM)


Simple, to be clear, I find 99% of what you post to be interesting and thought provoking... don't want you to take my response the wrong way.

That said, It appears you're cherry-picking (selection bias), not seeing the bigger picture, Shap illustrates that with the comparison to RADS fall since 2007 and failure to recuperate that loss.

You can focus on RAD being up 950% since 2009, but that still leaves it at minus 60% since 2007, substantially below its peers who have fully recovered and then some....even more so in the long term.

That tells a story.

When you look into it's long term history relative to peers, it appears that RAD is extremely sensitive to economic conditions, driving revenues off the "table scraps" WAG, CVS and others leave behind.



On MSFT, you're doing the same thing, selection bias, selecting a portion of time and two incompatible circumstances to see what you want to see, while ignoring the bigger picture,

MSFT is a large cap - it's going to move less in uptrends, but fall much less in corrections.

This is the same chart from 1995, go back further and it's even worse.





Again, I'm not specifically saying RAD is either a buy or sell, only saying a stock that's below $5 is there for a reason and getting back above $5 is very difficult, it's always a good idea to research why it got there to begin with....or just look for good values above $5.





Posted by stoicathos on May 13, 2013 (02:38PM)

Pros: You learn a valuable lesson

Cons: You lose money.

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