I know that most investors don’t buy true penny stocks very often. And to be clear, I’m not talking about $5.00 stocks, but rather those that trade for around a dollar or less – true penny stocks.
And when they do, most investors buy penny stocks hoping that the stock will rise by hundreds or even thousands of percentage points to generate a huge return. Usually, there is a great story behind the company that makes it very hard to resist.
The unfortunate news is that penny stock speculations often fall short of lofty growth expectations. Many investors get burned and when you get burned you hesitate to take on such huge risk again. That’s how it should be.
But every now and then it is very tempting to dive into a penny stock. And personally speaking, I find that at least wading into the penny stock pool can be a very interesting, and occasionally lucrative.
For these reasons I don’t like to dissuade risk-tolerant investors from buying penny stocks as a general rule. In many cases, there are legitimate businesses that we can invest in for a fraction of the cost of a traditional stock.
And when the opportunity looks good, I see no reason to cross a company off the list simply because of its small size and inexpensive share price. In fact, in the right situation these can be positives, not negatives.
But investing in penny stocks does require a different mindset then that which typically guides investments in larger, more established companies. Let me explain the basics of a penny stock strategy.
First, you have to view this as purely speculative. As always, don’t put money in any stocks that you need in the short-term. But that warning goes double – rather, triple – for penny stocks.
Second, there’s a penny stock strategy that has worked for me and maybe it will work for you, too concept that has worked for me when considering penny stocks. Maybe it will work for you, too.
I view buying a penny stock as being similar to buying a call option, but better. A traditional call option gives you the right to purchase a stock at a specific price before the option’s expiration date.
But with this “call option” penny stock strategy you get to decide when the expiration date is. It could be two months down the road, two years, or two decades. Since there is no set expiration date, your investment always has the potential to pan out provided the stock continues to trade.
Whereas many options expire and become worthless, your penny stock investment is likely to retain some value for a long time. And possibly, turn into a massive capital gain.
Exactly how long the stock is around depends on variables that you should have a feel for by doing your due diligence on the company. But your time frame can be infinite if you want it to be; you can hold these shares for as long as you want.
In other words, for a small sum of money, investors in penny stocks will own the right to participate in any upside. Just like an option contract (which is typically for 100 shares) is usually relatively inexpensive, each “contract” on a penny stock that trades for, say $0.50 cents, costs just $50.00.
You can buy hundreds of shares in a few different penny stocks for a relatively small sum. If you’ve done your homework and selected at least one winner, your potential gain should more than make up for any losers. And remember, you will have losers. This is definitely a case where you are swinging for the fences and hoping for one big home run to more than make up for your strikeouts.
Personally, I prefer resource stocks when it comes to penny stock “call option” investing, because it’s possible to buy several different companies that are all poised to benefit from the same catalyst – usually a potential oil or gold discovery in a certain region of the world.
In the resource world, penny stocks are more often than not Canadian-listed companies that trade in either Vancouver or Toronto, and on the pink sheets in the U.S.
As with any investing strategy, be sure to diversify and use proper position sizing to manage your risk.
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