How Stock Investing Works
Many stock investing experts believe that penny stocks are worthless, that investing in small cap stocks is dangerous and that investors should avoid them at all costs. This view is valid in various respects, except that by completely ignoring penny stocks, you are throwing the baby out with the bath water. Applying yourself to analysing small cap stocks through identifying excellent small companies can reward you richly. You may discover a future giant. You see, the “enemies” of penny stocks do not take into account that gigantic companies whose shares are now all time “blue chips,” once started as penny stocks.
When buying stocks you buy shares of a company. This company has decided to expand its activities, and to do that it needs money. One way of obtaining funds is to issue shares. The company has to be listed on the stock exchange, where the shares of all other listed companies are traded. Despite fluctuations, the share price of a prosperous company usually rises, but it can also drop when the company, for instance, does not show a profit. The price can also drop if the stock market as a whole has a downturn, often the result of broader economic problems, of a national or international nature. Sometimes a share gets a pounding because the sector of the market in which it operates suffers a drawback. Over time, however, the share prices of large, prosperous companies have risen dramatically, earning their shareowners huge fortunes. Today financial analysts show figures that confirm that stocks have outperformed all other investment instruments in the long term. Especially long-term investors are advised to keep a share portfolio in their investment portfolio to hedge them against inflation.
Selecting Good Stocks: Fundamental Analysis
As indicated above, you actually research the company and not the stock you are interested in. There are a number of guidelines to assist you when scrutinizing a company to determine whether it is worth investing in. The process is usually termed fundamental analysis. The greatest stock investor so far in history, Warren Buffett, uses only fundamental analysis to select stocks that meet his criteria.
We shall now discuss the criteria for selecting good stocks. Note that these criteria are applicable to all stocks. They entail Fundamental Analysis and Technical Analysis. After this, we turn to penny stocks to explain their specific characteristics and information on how to find them.
Four of the most important requirements when studying a company are:
• Product: Is the company’s product something new, or does it fill a gap in a particular niche? Is it a quality product? If not a new product, will it compete effectively with existing products?
• Profitability: Does the company make a profit and has it made profits over a period of three or more years? What do its debt levels look like?
• Resilience: How robust is the company? Does it have the potential to withstand inflation, higher interest rates, a rise in fuel prices etc.?
• Management: Is the company’s management competent? Are they people with integrity, good reputations and diligence? Do they publish financial reports regularly and on time? Do they have open communication with their shareholders? The CEO (Chief Executive Officer) plays a key role in the management of a company. Although this must be a consideration, it does not mean that a CEO with a magnificent record with one company will automatically achieve the same proficiency with another.
Selecting Good Stocks: Technical Analysis
Another method to uncover the best stocks to invest in is to use an instrument that is termed technical analysis. Technical analysis attempts to determine future price trends by analyzing factors such as previous prices, trade volumes etc. A variety of indicators presented as graphs show statistics on shares and market sectors. Using these indicators can give you an indication of the current achievements of market sectors, while also assisting you in selecting the best stocks in a specific sector. The most important value of technical analysis is that it assists you in your decision when to buy and when to sell a stock. Some of the most used technical indicators are moving averages, bar graphs, trend lines, support and resistance, volume, momentum, relative strength, overbought/oversold oscillators, and stock patterns such as head-and-shoulders formation. Since these indicators are presented as graphs, it will be necessary to consult internet websites that provide these technical graphs. To utilize technical indicators best, special stock market programs are available to assist you with technical analysis when you have become an advanced investor.
It is now time to take a closer look to arguments about penny stocks. To start with: what is a penny stock? Penny stocks (or penny shares) are similar to other shares that you buy on the stock market. The important difference is that penny shares are cheap to buy ($5 or less per share, but there is no consensus over the amount). Often new and small companies issue these shares with a much smaller market capitalization than other stocks. This explains why they are relatively cheap. Methods and techniques to select penny stocks do not differ radically from those used to pick other stocks.
Penny Stocks Versus Other Stocks
What do small cap (penny) stocks offer? Why are they a buying proposition for a small investor? There are quite a few answers. Firstly, not only are penny stocks affordable (and therefore within the reach of less affluent people), but there is more scope for their underlying companies to grow. The share price of a young, prosperous company that has proved itself over a period of more or less three years, often increases by 40%, 80%, 120% or even 400% within a short length of time. On the other hand, a so-called “blue chip” stock held by a large, established company and costing $45 per share, is unlikely to move with such leaps and bounds. Secondly, small cap stocks are often less prone to big market movements.
Admittedly there is another side to this argument as well. Let us be honest, the large majority of penny stocks are indeed worthless. One penny stock experts reckons that over 97% are complete failures. The reason for that is that the majority of small companies are duds, incapable of getting off the ground, resulting from inadequate financial resources, poor management or other problems. Therefore it is of utmost importance to find the pearls and to recognize the fly-by-night companies so that you can avoid them. In that sense it is true that penny stock investing is risky. By nature penny stocks are also more volatile than the more established stocks. However, the risk factor is not limited to penny stocks. The stocks of large companies can also be risky not only because they can fall victim to market crashes, but also when they perform poorly and prove to be a loss to big investors.
Bear in mind that the price of any share may drop as low as that of a penny share. In some cases even lower. The reasons for that do not necessarily differ from those causing the downturn of penny stocks. A number of reasons can be responsible for this, including losses made by the company, bad management or an extraordinary meltdown of a whole sector.
Where do I Find the Information?
The important point is that penny stock selection and trading do not exist in isolation. Small companies with huge growth potential and rock bottom stock prices may be identified in similar fashion than other stocks, but with more circumspection. That means you should acquire knowledge about the stock you are interesting in as well as the broad trends on the stock market at the time you want to buy. In other words, you should do your homework properly. Contrary to the notion that investing in stocks is only for experts, more and more ordinary people become interested in and informed about stocks. Nowadays there are so many stock investing guides (hard copies, ebooks and online products) that anyone can learn how the stock market operates, how to select good stocks to buy, how to manage them and why and when to sell them. To many individuals stock market investing has become a hobby.
A good place to start when gathering information about penny stocks is the internet. Not only will you find websites with valuable information about the economy in general, the oil and gold price, interest rates, inflation rates, currency values, company news etc., but also sophisticated stock investing programs containing graphs of every stock and every sector of the stock market. These programs also enable you to use the two main tools to evaluate stocks: fundamental analysis and technical analysis. When you become acquainted with analysis of company results, you can find these results in newspapers and on the internet. A number of new penny stock online programs have demonstrated astonishing techniques to uncover the jewels among the heaps of trash. Of course tons of money cannot be guaranteed; but there are customers who have reported amazing results.
Newsletters and Forums
Some websites issue free regular penny stock newsletters. These newsletters contain priceless information about companies, stocks and methods to explore penny stocks and their underlying companies. Online penny stock forums where participants discuss the merits of a product are equally useful.
Similar to penny stock forums are customers’ reviews on a topic posted on a website. In some cases the customer reviewers award ratings to the programs or books on offer. Here you can expect diverse opinions, and you have to use your own judgment to decide which reviews are more trustworthy and balanced than others.
The growing literature on penny stocks has de-mystified investors’ doubts about trying out a potential gold mine. Success with penny stock investing is not out of your reach. Start doing research on small companies with good financial results, sufficient cash and competent management. Thus, gather as much information as possible from the internet, buy and consult the best available guide(s) and get on with this profitable and highly interesting financial enterprise. It could change your life.