Should I Invest in Penny Stocks?
If you want to get rich quick with no effort at all then penny stocks are for you. If you think it would be a better idea to climb off of your unicorn and float down to earth instead of looking for a pile of gold at the end of a rainbow then you should stay far, far away from penny stocks. While the idea of making yourself an instant millionaire is a compelling one, I hope that my experience with penny stocks will help you steer clear the next time you start seeing dollar signs.
Penny stocks are the antithesis of investing
I originally became interested in investing in high school because I thought I could make money trading stocks by learning charting techniques from a few books. I read over 15 books on stock charts and investing, and when I finally turned 18 I put all the savings ($2,500 from various jobs) in a trading account so I could put what I had learned to the test. I began by trading stocks but it was moving too slowly for me. “How am I ever going to make tons of money buying XOM and YHOO?” I thought, “They only go up and a percent or two per day.” Soon I had started to buy penny stocks and options for some added leverage. It was not long before I had wiped out $2,000 of my original capital.
Despite losing such a large portion of my money I was committed to keep learning. In my first college years I continued to invest, but this time in just in stocks. Instead of buying large cap, well established companies I dabbled in much riskier small cap stocks. 2008 came along and you can guess what happened then. It took two major losses in my portfolio and classes in finance to kill most of the gambler in me when it came to stocks. Eventually my education got through my thick skull and I realized why penny stocks don’t make any sense as investments.
Investing is buying assets that generate a profit or some sort of return on investment
If your buying penny stocks thinking that you can “read a chart” or that you will have “good timing”, your are really gambling instead of investing. In order to actually “invest” in something, you have to be able to reasonably calculate the expected return (compensation) you will recieve from making that investment. After losing much of my money twice in a row, I came to a conclusion that ended up being the reason why I have stuck with finance/investment as a career. While I like gambling, I don’t like playing games where the odds are stacked against me. The beauty of investing is that it allows you to take calculated bets where the odds are IN YOUR FAVOR. Why are the odds in your favor? Because typically companies either turn a profit, which is attributed to shareholders, or they pay an interest payment for the use of your money in the form of bonds. That means that I can make a mistake when buying a stock by miscalculating the expected return and still make money in the long run because that company is adding value to my shares through profit.
With penny stocks you are investing in companies that are either losing money or are very near to collapse. This means that your “investment” in penny stocks is depreciating over time. Buying a penny stock is like buying a new car (cars usually depreciate in value over time) and storing it in your garage for 20 years, never driving it and hoping that at the end of 20 years it will be a collectable and worth many times what you paid for it. It is very difficult to predict which penny stocks will begin to make money, increase in value, and become viable investments. In a sense, buying a penny stock resembles playing a slot machine at a casino. You know that the house is taking money from you every time you press the “go” button, but you keep pressing it in the hopes that you will hit the jackpot. Penny stocks lose money, making the value of their stock less and less as long as they continue to lose money. The question is, is it worth watching your “investment” depreciate while waiting for a huge bounce in the stock so you can sell it at a profit?
Trading itself is a zero sum game, meaning that the net effect of traders buying and selling stock to each other is zero. The only thing that can actually make a stock appreciate in value is an increase in the perceived value of the company (its potential profitability). While penny stocks clearly carry “perceived value” because they are losing money and yet people are still willing to pay for them, the actual value of these companies is as illusive as your unicorn up on the rainbow of your penny stock dreams. If you are ready to come down to earth I suggest you go with investments that have the odds stacked in your favor, not the other way around. I understand that buying profitable companies may not be as exciting as buying penny stocks, but in the long run you’ll be better off buying companies that are paying you to hold their stock instead of companies that are actively destroying your hard earned money.