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Penny Stock Dangers

Updated on September 4, 2011

Penny Stock Dangers


The general investment community always seems to issue warnings about potential “penny stock dangers” as if these kinds of stocks are really any more risky than any other investment class—I happen to part ways with most people when it comes to this point of view. True indeed, penny stocks for the most part usually offer a higher rate of leverage than other assets, but this does not make them any more “dangerous”, per se, than any other investment, IF the investor is uninformed. I will continue to maintain that it’s not really the investment that’s risky (or dangerous); it’s the INVESTOR that’s risky, when he/she doesn’t know how to handle the investment. It all comes down to developing the proper skill set for trading so that you will be able to feel comfortable handling stocks with a higher level of leverage. It all comes down to practice, discipline, and consistency in applying a solid trading methodology; developing these skills can help you navigate through the choppiest of investment waters. There are people out there, such as performers in Las Vegas and the like, that know how to skillfully juggle flaming torches while riding a unicycle, and through years of practice they have become so proficient at it that they can do it now without even thinking about it. Doing those “dangerous” stunts to them has become as commonplace as buying a loaf of bread. This comes only one way—by lots and lots and lots of practice. The same holds true in the investment arena—there are traders out there that can handle huge quantities of shares and crazy fluctuations in price, because they have trained themselves to not react emotionally to the markets, but to approach them with a cool, calm methodology that focuses only on price objectives and capital management.

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Examples of Dangers of Penny Stocks


So what are some of the “penny stock dangers” that exist out there? Well I’m definitely not a “guru” by any stretch of the imagination, but I can relate some of my observations and experiences here for your instruction and hopefully for your benefit. One of the things I’ve noticed over the years in dealing with penny stocks is that people tend to apply a long-term investing mentality to the penny stock markets, and that is an approach that is destined to fail. Penny stocks are not meant to be “buy and hold” instruments, if you really plan on making money with them. Now if you just want to have a sense of “pride of ownership”, then yeah, hold on to your penny stocks, but believe me, sustained rises in penny stocks are very rare—for the most part, it’s a “pop and drop” affair. In other words, when a move in price happens, usually the price of the stock will pop up quickly, and then drop just as quickly. That’s simply the nature of the game. So you really have to be “on alert” if you are going to trade penny stocks with any degree of success. Another danger (if I may call it that) is the potential for illiquidity in the market. This can be due to the fact that many penny stocks are thinly traded—that is, you cannot enter and exit freely in and out of the stock, because either the volume is too shallow or the spread is too large. When the spread is too large (i.e., there’s a lot of distance between the bid and ask prices), you’re going to get crappy fills on your orders, ESPECIALLY if you use market orders, which are virtual suicide in the penny stock markets. One other thing to be aware of is the potential for the stock to literally go bust before you get a chance to see any profit from your trade. I have had this happen to me before, and in that case, you’re simply stuck like Chuck.

But that’s the whole thing that I keep trying to emphasize to people—you should never invest more money in a penny stock than you are willing to comfortably part with. I realize that it’s never comfortable to part with your money, but it’s one of the things that you have to accept if you’re going to navigate these penny stock markets with any degree of success.

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