Will Penny Stocks Make You Money?

Brandon Wendell
Instructor, CMT

I’m sure you’ve heard of penny stock investing before. The lure of making quick money draws many people to the world of trading and investing.  A lot of them start by buying shares in microcap companies also known as penny stocks.  The problem with these types of stocks is that the likelihood of profiting is, well, not very likely at all.  Smart, consistently profitable traders do not take risks with their money that are unlikely to pay off.  Trading is speculation and doing so with high probability.

Free Trading WorkshopThe reason people are attracted to these penny stock investments is that they may not have a lot of money to invest or they have heard stories of people who have doubled or tripled their money by investing in these securities. The problem is that for every success story in penny stocks, there are a dozen more failures and losses.

Let’s examine why trading or investing in penny stocks is not a good idea compared to finding high quality opportunities.  Online Trading Academy’s core strategy is successful for many traders and investors because it is based on a simple principle: find out what the banks and institutions are doing in the markets and trade the same way.

Imagine if you will that these banks and institutions are like sharks.  This won’t be too hard if you have ever lost money in the markets.  The sharks go out and seek their prey much like the institutions take profits from individual traders and investors who have no knowledge of the markets but still try to trade.

As traders, we do not have the funds available to become a shark.  Instead, we need to be like a pilot fish.  These fish swim along with the sharks and get to feast on the leftovers, much like educated traders get to see where the institutions are buying and selling and place their orders in the same zones.

When you examine the information for a typical large cap company, you will see that the institutions are heavily involved.  Their ownership of the shares available can range from 50% to 90%.  When they are actively involved in a stock, you can see their trading activity on charts and identify high quality supply and demand zones in which to trade.

There is risk in penny stock investing

When you look at a penny stock, the institutional ownership may drop to zero. Many institutions and even hedge and mutual funds are prohibited from trading in these securities due to the extremely high risk involved.

Penny stock investment information

What makes matters even worse is that when you look at a chart of these penny stocks, it is impossible to locate the high quality zones required in order to increase the probability for making money in the markets.

Things to know if you're thinking about investing in penny stocks

The penny stocks used as examples in this article were selected because they were found as “hot stocks,” on a penny stock website. If you were thinking, “Well, these stocks look terrible; I could just short them and make money,” you would be mistaken. Even if you happened to find a good zone, current SEC regulations prohibit the shorting of penny stocks.

Penny stock chart

Should you want to become a consistently successful investor or trader, you should stick with the listed stocks as there are known risks that can be managed.  If you still want to risk your money on penny stocks you need to know several things.  There are two over the counter systems (OTC) that allow you to trade penny stocks:  the OTC Bulletin Board (OTCBB) and the OTC Link formerly known as the pink sheets.

The first hurdle that you would have to overcome is the lack of information.  The OTCBB listed companies are required to disclose important financial information such as earning and material events.  The OTC Link companies have no such reporting requirement and you will not have much information.

There is also a low volume problem with penny stocks.  Low volume means low liquidity.  That means that even though you can afford to buy a lot of shares, when it is time to sell you may not be able to get out easily or at a decent price.

The low volume also makes these stocks vulnerable to price manipulation.  Many people are familiar with the movie, “The Wolf of Wall Street.”  In this movie, penny stocks were sold to individual investors in order to pump up prices. When the share prices were high enough the broker and their friends would dump their shares leaving the individual investors holding onto worthless stock.

It is unfortunate, but this “pump and dump” scheme is not only a movie plot but occurs in real life.  There are thousands of hungry wolves ready to feast on your money.  Do not jump into stocks featured in promotional emails or websites without considering the risks and doing your own research.

Making money in the markets can be done.  The best way to do this is by trading and investing in high quality stocks with good institutional participation and identifiable chart patterns that increase your odds.  Penny stock trading does not meet that criteria.  Proper trading and investing is a high probability way to meet your financial goals.  To start planning your path to your financial success, visit your local Online Trading Academy center today!

Brandon Wendell

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.