Topic: Penny Stocks

Investing in penny stocks long term is riskier than you might think. Here’s why

Investing in penny stocks long term could lead to big returns—but only if you find the right ones. Meanwhile, it’s likely that the longer you hold pennies, the greater your chance of losing it all

Do you plan on investing in penny stocks long term (or short term for that matter)? Penny stock bubbles have helped investors profit—however, when the bubble bursts, prices of low-quality stocks inevitably come crashing down.

Ultimately, penny stocks should only be a small part of any diversified portfolio, if at all. And you should only buy the most speculative of them with money you can afford to lose.

Are Penny Stocks Worth It?

Learn everything you need to know in 'Canada's Penny Stock Guide' for FREE from The Successful Investor.

Canadian Penny Stock Guide: Find where to find Penny Stocks that pay well.


Investing in penny stocks long term can turn the odds against you

Many investors are attracted to penny stocks because they are cheap. It doesn’t take a large investment to buy a significant number of shares—for example, $1,000 can buy 10,000 shares of a stock that’s trading at $0.10 cents. If you have a large position in a $0.10 cent stock, a share price rise of only $0.05 cents can make for a substantial 50% gain. However, there’s a good chance the stock will decline. Being speculative ventures, the vast majority of penny stocks fail, putting your entire investment at risk if you hang onto them too long.

If you lose money in speculative pennies or other 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. (That’s a key difference between a penny stock vs. regular stock.) Still, even with luck on the side of the penny stock investor, if they play long enough, the “house odds” eventually triumph over any run of good luck.

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.

In penny stocks, as with 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.

Use the sell-half rule while investing in penny stocks long term

The sell-half rule recommends that you sell half of a stock that doubles in price—and you should be quicker to sell aggressive stocks than conservative stocks. It also pays to apply our sell-half rule with stocks we rate as “Speculative” or “Start-up.”

Selling half of hot stocks that surge helps you guard your profits. But in general, apply this rule only to more aggressive stocks, and not to the well-established stocks that may surprise you by going a lot higher in the long run.

Selling half after a stock’s price doubles makes sense in a high-risk investment such as a penny mine. That way, you get back your initial stake. This can give you a clearer perspective on what to do with the other half of your investment. If you are too slow to sell speculative stuff, after all, your profits and even your principal can evaporate all too quick.

However, as mentioned, it’s generally a mistake to apply this rule to your best holdings that are not high-risk investments. To succeed as an investor, you need to hold on to your best picks for lengthy periods. If you’re too quick to sell, you’ll never hold a stock that vastly outperforms the market, and you need a few of those to offset the inevitable disappointments.

Learn to identify a good time to sell while investing in penny stocks long term

Sometimes a penny stock will announce a deal with a major company and its value will increase dramatically. When this happens, it’s often a good time to sell. Also, if one major investor sells, trouble may be on the horizon—it can cause an abrupt price slump, making it difficult for even the most promising of startups to attract additional potential investors. This is especially true if the stock is a “thin” or “illiquid” trader because it doesn’t take much buying and selling activity to influence its price. Time is not on your side when investing in penny stocks—the longer you stay invested in volatile stocks, the more likely it is that you will lose not only your profit, but your principal as well.

Use our three-part Successful Investor approach for investing the bulk of your portfolio

  1. Hold mostly high-quality, dividend-paying stocks.
  2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
  3. Downplay or stay out of stocks in the broker/media limelight.

What is the longest period of time you’ve held a penny stock while it remained profitable?

Do you think penny stocks are worth the gamble, or do you stay away from them and stick to more low-risk investments?

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