by As a general rule Penny Stocks (those under $1) are categorized by high volatility. They can have massive swings in value going from mere pennies to more than a few dollars or they could go bankrupt and no longer be available for trading. With this volatility we generally recommend avoiding them until you have a balanced investment portfolio.
Of course balancing risk is part of investing and if you have developed your financial portfolio to the point where you would like to try something with a bit more risk then we want to share how we have approached investing in penny stocks. Investing in penny stocks should still align with your financial goals and contribute to your overall strategy.
Our approach to investing in Penny Stocks is based on the aspect that they won’t be held for a long period of time, meaning that you might hold the stock for a maximum of a few months. This shouldn’t be confused with high volatility day trading that you might find others recommending as we believe that is a different skill set and one that can take up a great deal of time. Consider the following aspects to identify the right opportunity for penny stock investing:
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- Market Movers – Most trading platforms will have a report that shows the largest of market movers for a given exchange (i.e. NASDAQ, NYSE). When looking for an initial opportunity look at this report to find potential stocks to invest in. While it might be attractive to look at the stocks that have had recent large %daily gains (i.e. 20% or more in a day) those are the ones we would encourage you to evaluate at a later date. The screenshot below is from E*TRADE and your eyes should be drawn to the red to evaluate those as an opportunity. Keep an eye on OCGN…more on that later.
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- Price – While it might sound obvious, you will be looking for stocks in the <$2 range. This low price point will allow you to buy a higher volume of shares which will help you realize a larger monetary gain with a relatively small investment. For example, consider that if you purchased 100 shares @.50. Your investment would be $50 which is a great way to start investing in penny stocks.
- Share Volume – As penny stocks have a lower per share price than your large cap stocks we would encourage you to purchase a few hundred shares if you can. Purchasing a few hundred shares gives you a few benefits:
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- Monetary Gain – If you have 200 shares and the stock goes up by $1 then you can enjoy a $200 gain when you sell. The % gain would obviously be very large at a $1 movement, but at the end of the day you are trying to cash in with actual dollars, not just demonstrate a strong % yield.
- Opportunity to Sell a Portion – When you purchase a few hundred shares you have the option not to sell all of your holdings when it hits your target price (more on target price below) giving you an opportunity to experience an even larger gain while taking your initial investment back with a gain.
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- Large Delta in Current Price vs. 52 Week High – The goal of a penny stock purchase, from our perspective, is to look for a gain that can be 3-6x your investment and to get this we need a large delta from the current price and the 52 week high. Take the symbol we shared above in the market mover report, SNDL, which at the time of our documentation (12/28/2020) was trading at .47 but the 52 week high was $3.88. This means that, theoretically, if it reached its 52 week high again you could have a 7x+ return on your inve
stment! - Set Your Target High Price – Looking at the large delta to see your potential upside is key to identifying the opportunity and it is equally important to identify at what price you will be satisfied. In the example of SNDL, if you purchased at .47 and it went to $2.00 you have 4x your investment. While that isn’t the 52 week high that is still an incredible gain! Set your alert in your trading platform at the price you are comfortable with and be prepared to sell some of your position as these stocks can have extreme volatility that can take away your potential gain in a single day.
- Why is it Low? – Before making your purchase look at the company news feeds to determine why the stock is low. In the small cap pharma stocks they are often low because they have been investing in R&D and their drug has not yet been approved. Some companies are low because of industry shifts (i.e. fashion companies). Read through the news to see if the reason for the current low price isn’t detrimental to the health of the company as you want to minimize the risk of it going to $0.
Keep in mind that going through this evaluation process will take time daily before you find a stock that you can have confidence in and has a price point you are comfortable with and provides the commensurate 3-6x+ return. We would recommend purchasing 2-4 different penny stocks in different industries to allow you to see what will work. This is not only a way to help you test your evaluation process but also can help you mitigate risk as if 1 stock fails.
Real World Example
Following the above outlined methodology, I purchased 1,000 shares of the stock OCGN. Now keep in mind I purchased this stock over a period of months for varying prices ranging from .54 to .28. We list it that way as truthfully the first purchases were at .54 and the stock went down over the next couple of months which certainly wasn’t the desired outcome initially.
When the stock reached .28 I purchased 500 shares to bring my total to 1,000 shares which also brought my overall average cost down. Just a few weeks after that purchase the stock experienced a large movement to over $1 which was above my original goal. Of course, just like anyone, I let a day get away from me and I didn’t end up selling at that price. In this scenario that delay was a big benefit as the next day the stock moved to $2.80 and that is when I sold 500 shares to take back my original investment and a 600%+ gain.
After discussion with Joe I did keep 500 shares to see if it was possible that the stock could experience even larger gains. As you can see from the screenshot below (from 12/28/2020) the stock is trading below $2.80 but my gain is still well over 600%.
