My name is Hanna Volkava, I am an author of articles on myfin.us. Today we are going to figure out how to make money on stocks and which stocks to choose.
Beginning investors often think that cheap stocks represent a lucrative opportunity. They think that the lower the stock price, the higher the profit potential. If a stock that costs $1 goes up by only $1, your investment will be doubled. To get the same result in a $100 stock, the stock would have to grow by $100, which is almost unrealistic. These maths are correct, but they mislead the novice trader. The secret of successful trading on the stock market is patience. Investors look for cheap stocks (usually small or micro-cap stocks) based on the calculations above.
If you believe the ads, people are making huge money on these securities every day. Yes, it may happen. But in general, when you buy cheap stocks, there is little chance of getting rich. Rather, you can lose money. Cheap stocks are hardly a worthwhile investment. They don’t behave like regular stocks. They are not listed on any of the major stock exchanges (as far as OTC securities are concerned). Even if you open a trading account with a good online broker, buying cheap stocks presents some challenges. Any normal broker will give you the opportunity to trade them, but with special rules.
Selecting good cheap stocks to buy
There are three obvious ways to invest in cheap stocks. Each of them is difficult and does not guarantee earnings. It is much easier and less risky to make money if you invest in companies that meet the value criteria. But it will take patience: first, you have to find a good opportunity and then wait for the results.
Pump & Dump
Pump & Dump is the most popular strategy for trading cheap stocks. One buys a stock at a low price and convinces other people that the stock should be worth much more. Then they sell the stock when a rush of demand increases the value of the stock. Unfortunately, this strategy is considered unethical and, in some countries, even prohibited. Its implementation is also very difficult.
Every investor encountered advertising mailings, praising some penny stocks. They promise that their price will skyrocket. The stock is about to explode! Better buy now, or it will be too late! Calm down and think twice.
If the stock is really about to go up in value, there must be a reason for it. Perhaps this company’s business has improved. Perhaps this company is being bought by another company. Maybe they are going to get a huge exclusive order. If the person who sent you the marketing letter knows why the price should go up, ask yourself two questions. First, why is this person advertising this particular promotion now? After all, it is inevitable that such a solicitation will cause the price to go up. Why wouldn’t he take a bigger position himself? Second, how does this person know that the price will go up?
Most likely, your anonymous friend bought the stock for 25 cents. And now he wants as many people as possible to buy the stock at 50 cents. So he creates a frenzy and attracts more buyers as possible. There has been no change in the company’s business. The value of the paper is still 25 cents. This is a scheme to make multiple profits. It is not at all designed to help you get rich.
This is a much more ethical way to buy stocks because you buy the securities of a valuable company and then hold the position until the price reaches a point where you are ready to make a profit (or loss). Unfortunately, luck is an unpredictable business. There is no easy way to generate a list of all the good cheap stocks to invest in. Not all good stocks are cheap. And certainly, not all cheap stocks are good. After trying to build a business and a series of financial setbacks, a company can walk away from the market. In doing so, the company will sell off all of its assets to creditors and pay you only a fraction of what you invested in its stock.
Of course, the company may get back on track. But a cheap stock is priced that way for a very specific reason. You have to realize that unless you’re a gambling enthusiast. In Las Vegas or Atlantic City, at least you know your chances of winning before you bet. There is no such guarantee in cheap stocks.
Find a stock coming out of the crisis
Sometimes companies go through horrible bankruptcy proceedings. Such a procedure ends in a restructuring (or buyout) at a good value. Perhaps such a company has freed itself from huge debts or has significant inventory, equipment, real estate, patents, or other valuable assets that have attracted a buyer to it.
Perhaps with careful management, the business will pick up.
Such investments are extremely rare and very risky. It is hard to predict when an airline carrier will get back on track, or when a Canadian plutonium mining company will find a new vein. But it can happen.
If you do your value analysis carefully, you can sometimes find a company with potential. Sometimes the market acts irrationally and undervalues a business. This is unfair, but it does happen, and good opportunities for investors are opening up.
Unfortunately, it rarely happens in cheap stocks, but nothing is impossible.
What does a business have to be to make this happen?
– Actually, be profitable (you don’t want to invest in a company that is making a loss)
– have sufficient assets or generate enough cash flow to pay its creditors and not exit the market
– Implement its strategic plan to return to one of the leading stock exchanges.
All of these factors are necessary to reduce the risk of an investment.
Should I buy cheap stocks?
Even if a stock is selling at a very attractive price and you think that the 25 cents invested could easily double or triple, remain cool and cautious. Do your research. Don’t try to get rich by devoting all your time to finding the miracle cheap stock. Strive to earn consistently by adhering to the principle of investing in value. It’s better to select quality stocks at good prices, which you can learn by taking a trading education course.