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A Reverse Approach To Choose The Right Penny Stocks – Part II

Today, I’ve done a lot of review on my previous topic, how to lose money with penny stocks. To recap, my hypothesis is that if I learn what NOT to do first, that is, learn how people lose money with penny stocks, I will have that firmly imprinted in my mind as I go forward with actually learning what penny stocks to buy.

First and foremost, there really isn’t a lot of information out there in terms of how people lose money at penny stocks. Granted, there are a lot of cautionary tales of woe, with folks losing a fair amount of money, but when it comes down to the details of how and why, the information is lacking.

The few sites I was able to find, along with a somewhat useful YouTube video, are linked as you read through this post. Here’s what I learned from my research:

Penny stock scams are abundant. You need to be very cautious when choosing what penny stocks to buy!

A very reliable site, investopedia, provided a rather basic article with some insights on penny stocks, including a bit of useful information on scams that pervade penny stocks. The first of these is the biased recommendation. It seems that struggling companies will pay people to recommend a certain stock (i.e. their stock!) which is clearly a biased recommendation and a conflict of interest. A second scam is the struggling company will sell their stock to an offshore broker (which exempts the company from having to register their stock with the SEC), and then the offshore broker calls potential investors and uses high-pressure tactics, akin to a used car salesman’s techniques, to pressure folks into buying the stock.

Ugh! No wonder penny stocks have a bad name.

Trendshare.org also has an article with a bit of information regarding people losing money with penny stocks. They highlight the “pump and dump” scam, which I’ve at least seen before. As the article defines it, essentially in a pump and dump scam, a worthless stock is “pumped up” through recommendations, and utilizing the group psychology technique of “not losing out”. This “not losing out” idea holds that people tend to follow the herd and people don’t want to lose out on a potential opportunity. Then once the stock price rises, the person at the source (the “pumper”?) sells all of his shares at a profit, leaving these other folks holding a really worthless stock. The article also notes the ubiquitous penny stock newsletters, which promise the “hot stock tip” or the “insider tip”, which usually is a crappy recommendation.

The most useful article, however, comes from Michaelsincere.com, which is an interview with a penny stock trader (and author) Timothy Sykes. Tons of useful information in this article on why people lose money with penny stocks. Here’s the ways people lose money:

Relying on penny stock newsletters, as I noted above. Sykes notes that the fine print of these newsletters usually reveals an SEC-mandated disclaimer that specifies the conflict of interest! Amazingly dishonest!Being greedy. This is apparent in any investment, in that if you see a 10% or 20% return, you immediately want a 30% or 40% or greater return, and will hold onto a stock longer than you should, instead of exiting, taking profits, and looking for the next penny stock to buy. You have to not be enamored with a stock and look at it 100% objectively and go with your hard analysis, not your emotions. Especially difficult can be the idea that “I failed because I lost money on this stock”. That thought needs to be stricken from your consciousness as each loss is not failure, but an opportunity to learn. I’ve been guilty of this before, so this is something I’m going to have to watch out for myself.Listening to information from the companies themselves. Since penny stocks don’t have to adhere to the same regulations as larger-cap companies who are listed on the major stock exchanges, there’s ample opportunity for companies to outright lie and manipulate their data. Easy enough to avoid.Trading stocks that have limited volume. Let’s say you own 2,000 shares of a stock that has a share price of 10 cents, for a total investment of $200, and the average volume of shares traded is 10,000 shares per day. If that stock drops in price by a cent or two, that’s a huge move, and now you want to sell your shares quickly. But, now you own 20% of the average trading volume. How are you going to be able to find enough people to buy your 2,000 shares of a stock that’s dropped in price by 10% or 20%? You’re not. So, simply avoid trading more than 10% of a stock’s daily volume and trade stocks that have at least 100,000 shares per day traded. Easy enough

The last resource I’m listing here is a video from pennychase.com which lists many of the same things I mentioned above, but is somewhat interesting to listen to. Remember, however, that this is a video made to sell Penny Chase’s service, so there’s a sales pitch starting at the 3:30 mark of the video. I certainly don’t endorse their service nor do I plan to use them for their service, but the information in the first 3:30 of the video I think is useful enough to listen to.

So, that’s it for now. I’m going to distil this all down into a quick reference “How To Lose Money” Post in the Resources page. I plan to have this printed out and available whenever I’m going to actually choose what penny stocks to buy so that I have that idea of what NOT TO DO right at the forefront.