In addition to the material in the print or e-book you’re reading right now, this product also comes with some access-anywhere goodies on the web. Check out the free Cheat Sheet for tips on protecting yourself from penny stock pitfalls, crucial criteria found in great penny stocks, and the no-cost method to becoming an excellent penny stock investor. To get this Cheat Sheet, simply go to www.dummies.com and type Penny Stocks For Dummies Cheat Sheet in the Search box.
This book is set up so you can get right to the information you want. By all means, start at the very beginning if you feel like it, but if you’re like most people and have only so much time to devote to investing, flip right to the sections that interest you.
Decide what approach works best for you, and use this as a reference for anything you could possibly want to know about penny stocks. The table of contents and the index will help with that, or just visit the specific parts that will provide you with the most benefit.
Part 1
Getting Started with Penny Stocks
IN THIS PART …
Find out what characteristics distinguish penny stocks from other types of shares.
Uncover the truth about common assumptions – both positive and negative – about low-priced shares.
Get the scoop on which stock markets are the best for penny stock investors.
Examine the differences between investments of various sizes.
Become acquainted with events that can impact a company and its shares.
Learn how to protect yourself from scams and low-quality companies.
Chapter 1
Getting to Know Penny Stocks
IN THIS CHAPTER
Getting to know penny stocks
Separating fact from fiction: The truth about low-priced shares
Penny stocks are shares of companies that trade at low prices – typically anywhere from one cent to five dollars per share. The low-priced shares are usually associated with very small companies that are just getting started. When the companies grow, the value of their shares increases, making money for anyone who owns the stock.
I just described the upside of trading in penny stocks, and it’s this potential for making money that explains the growing popularity of this type of investment vehicle. Of course, not all small companies thrive or even stay in business – which brings me to the downside of penny stocks: Should the company shrink, or run into any number of other problems that I describe later in this chapter, stockholder shares will decrease in value, leaving investors with a partial or potentially complete loss of their investment.
Many investors are drawn to penny stocks because they find the upside compelling. They’re intrigued by the idea of investing in a tiny company in its early stages and watching that money grow along with the company. After all, many companies that started out as penny stocks have gone on to become household names, making their early investors very wealthy in the process. Few other investment vehicles offer the possibility of turning a small amount of cash into a small fortune without even having to work at the company or break a sweat.
To succeed as a penny stock investor, you need to be able to maximize the upside (making money), while minimizing the downside (losing money). Unfortunately, far too many investors treat penny stock trading more like a get-rich-quick scheme (or a trip to the casino) than a legitimate investment strategy. But as I explain in this book, there is a right way to trade penny stocks and a wrong way. Said more directly, there is a profitable way and a costly way. In this book I give you all the information and tools you need to avoid the downside, while benefiting from owning small shares that have the potential to grow exponentially.
The first step to reaping the rewards of penny stock investing is to understand the basics, and the process of gaining that knowledge begins in this chapter. I begin by separating fact from fiction, exposing the truth about penny stocks and letting you know which rumors and innuendos have some basis in reality (spoiler alert: A lot of the negative things that you may have heard about penny stocks are actually true). I also offer a clear definition of penny stocks and fill you in on the ways that they’re unique investment vehicles.
Companies usually need to raise money to operate, and the most common way to generate that cash is for them to sell shares of their corporation on the stock market. If they need more money at a later time, they can issue even more shares (see Chapter 3 for details on this process). The company gets money to operate; in exchange, the new shareholders get part of the company.
The shareholders will see the value of their investment in the company change based on what the share price does. If the company does well and grows, the shares typically increase in value. But if the business shrinks or runs into detrimental issues such as weak sales numbers, lawsuits, or new competitors, its shares will likely decrease in value.
Although the aim for most companies is to get bigger and bigger, the majority of them start out very small, with only a handful of employees or a total company value of a couple million dollars or less. Their shares may trade for a few dollars, or even pennies. However, those penny stocks may become worth much more if the companies grow. If everything goes according to plan, the stock won’t actually be a “penny” stock for long, and both the value of the shares and your investment in them will be dramatically higher.
A lot of quality companies trade as penny stocks and many of these will perform very well for their investors. Of course, because share price is a reflection of perceived value, many downright awful companies with no prospects, or even on the verge of bankruptcy, trade as penny stocks as well.
Unfortunately, the number of low-quality companies outweighs the good ones. In fact, only 5 percent of penny stocks I review pass my analysis. Combined with the propensity for promoters and shady characters to provide misleading information (more on the shadowy side in a bit), penny stocks have earned a bad name.
Some of the negative connotations surrounding penny stocks suggest that they are
❯❯ Hard to buy and sell: This is true for lightly traded shares on many of the penny stock markets. You won’t have this problem if you stick to shares trading on the better stock exchanges, which I detail in Chapter 3.
❯❯ Subject to scams: Unfortunately, penny stocks are the focus of many scam artists because of the opportunity to make money by manipulating the prices of the underlying shares. Dishonest promoters try to push up the prices of the penny stocks they own by tricking unsuspecting investors through free newsletters and message boards.
❯❯ Based on low-quality companies: The majority of penny stock companies are not strong – and that’s putting it kindly. The key is to avoid those lackluster stocks and instead find the top 5 percent that will be extremely profitable. This book details how you can do exactly that.
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