Although attractive to aggressive investors, there are many good reasons to sell penny stocks before you lose money
Some investors think the best way to profit in stocks is to buy them when they are just barely starting out on a growth phase they hope will last for years if not decades. Ideally, they want to buy the future top performers when they are still near or close to the penny stock range and have yet to be discovered by the broad mass of investors.
And it’s true that when you buy penny stocks you could have a big payday if you make the right choice. But the odds against success are high, so we often recommend investors not to buy them in the first place (or sell their penny stock holding).
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Big companies are more powerful in the penny stock game than individual investors
A major mining company will gladly spend $50,000 one hundred times, and lose every penny of it—a total outlay of $5 million—if this means it will get a chance to develop the one rare project that’s ultimately worth an investment of, say, $500 million. If it waits till the property, technology or program has proven itself, development rights will be far more costly. So it gets in early by investing what are really just token amounts of money for a major firm.
If the big company agrees to spend $50,000 to study the mining property, new technology or pioneering program, it will also insist on a series of options that let it invest ever-larger sums on favourable terms. But the big company will always reserve the right to drop out and cut its losses. In most cases, it will exercise that right.
That’s why big-company involvement by itself isn’t a good indicator of a penny stock to buy—in fact, it can be a reason to sell penny stocks.
Sell penny stocks before a bubble bursts because they fall quickly
In the early 2000s, buyers of Internet start-ups made far more profit than investors who stuck with well-established companies. The same thing happened when many investors bought low-quality resource stocks in 2007 and 2008, and it has happened in the past in penny stock bubbles. When the bubble bursts, however, prices of low-quality stocks inevitably come crashing down.
Sometimes penny stocks are just marketing campaigns in disguise
Penny stocks do sometimes pay off, but there are many pitfalls to avoid. You should be aware that many penny stocks are little more than very well executed marketing campaigns. After all, it’s much easier to launch a stock promotion than it is to create a successful, lasting business.
Penny stock promoters will do anything in their power to get their penny stock noticed. These extensive marketing campaigns include emails, TV interviews, podcasts and self-produced newsletters.
Penny stock promoters love to make deals—however small or indirect—with major, well-known firms. These deals are aimed at gaining the trust of investors as all penny stocks aim to do. The penny stock hopes that the link with a major brand will give them instant credibility, even if it far from guarantees any sales or profits.
The longer you hold penny stocks, the likelier you are to lose money
If you lose money in speculative pennies or other low-quality stocks (or ETFs that invest in low-quality stocks), you may think your main mistake was bad timing. That’s a misconception. All penny stocks rely on luck to become wildly profitable. If you play long enough, the “house odds” eventually triumph over any run of luck.
In penny stocks or games of chance, the odds are against you. So, time works against you. The longer or more often you play, the likelier you are to lose. That’s also why we think you should apply our sell-half rule.
Penny stocks are (way) riskier than other investments
Investors looking to add to the aggressive portion of their portfolios may turn to the higher-risk strategy of buying speculative penny stocks.
However, there are several potential risks when investors venture into penny stocks.
Buying low-quality penny stocks is one of those things that can appear to be successful before it goes badly wrong. Some get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than high-quality stocks.
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