One of the worst things which can happen to an investor is for them to lose their shirt. If you buy into a blue chip stock one day when it's trading around $50.00 and then you turn your monitor off for a few days before you notice your stock is trading at $5.00, you would be furious. You've lost 90% of your money. If you've invested in 1000 shares at $50.00, well I don't need to tell you, you don't quite have that same amount of money anymore. The roller coaster of investing makes most traders stomachs turn. Ask anyone who was on the floor buying up soon-to-be worthless shares of Fannie Mae in 2007 when the stock was trading at stellar highs of $65; two very rough years later the stock was trading at $.40.
For the blue chip investor these last few years have been unlike any others. For the penny stock investor though these type of swings are just par for the course. Penny stocks will lurch and leap and stall and croak and make investors mad as heck and then joyous from their giddy ether.
In penny stock investing you are talking about untested shares, generally; stock whose worth hasn't yet been determined and could go either way. Penny stock investing is risky for reasons beyond just that the security hasn't proven itself over the long term. Penny stocks are also stocks of companies who are trying to raise a lot of capital. Selling shares of stock is one of the best ways for a company with real intrinsic worth to raise this money. What often happens in penny stocks though is that this new product or service will overvalue it's worth at least in the beginning and there will be a decided spike followed by a slow drift downward.
If you are an investor who happened to buy in on the upswing you are holding onto all the shares of this company you can; trying to get more. If you were lucky enough to get in at the bottom and sell off before the downward momentum carried itself all the way out, then you have made your money and you are good. Generally though what happens is that the euphoria over a stock catches on and people pile in.
"Oh wow! A new way to manufacture old widgets! Brilliant!" Then when the euphoria dies down, the hangover begins.
American Scientific Resources (ASFX*) is one such stock that I've invested in which has taken me up and down the roller coaster. I first got into ASFX in September 2009. ASFX was trading around eight tenths of a penny. I got in over the course of several days between $.0072 and $.0098 for forty thousand shares. All in all my investment was $320. ASFX then went on a tear. I piled in with more shares actually increasing my average share buy-in as I picked up another 10,000 shares on September 28, 2009 when ASFX was trading at $.0245.
ASFX traded all the way up to $.08. I had an exit price which was never reached. Then ASFX began the slow drib downwards. Many investors never got out; holding onto these shares that they may have bought on the way up and it's hard to look at your account one day and say, "Well these 50,000 shares which were worth $4000 last week are worth $1000 today.
ASFX currently trades between $.0045 and $.005 but there is reason for hope if you are a shareholder as the company has recently finalized some deals.
Another problem with penny stock is the same as the first; this is a new company and they need money. So what penny stocks will often do is issue new shares! Issuing new shares to market is a great way to bring in new investors but this issuance is generally seen as a bad thing by legitimate investors or at least a reason to stay away for now. Then the value plummets because there are too many shares and not enough demand and you're heading down, down, down.
One such instance happened for my portfolio on 11/24/2010 when Solos Endoscopy (SNDY) did a 1000/1 reverse split. I only had 10,000 shares and these were bought at something of a peak but this reverse split really killed me. Today I have 10 shares of SNDY which sit in my account at -99.95% of their original purchase price. Even if I sold them it would cost me more money to execute the trade than those 10 shares are worth. I will hold onto these shares in the hopes that they do a forward split one day and the value rises. At the very least I can take the losses on my income taxes one year to help offset gains.
Of course penny stock investing has also made a few rich folks out of many. Imagine buying 10,000 shares of Microsoft when it was trading in the penny word in the 1980's? You may have had to wait a few years for the payoff but if you'd have bought in the troughs and sold at the peak it would have been a sweet payoff indeed.
Sources:
(1) http://finance.yahoo.com/q?s=ASFX.PK
(2) http://finance.yahoo.com/q?s=SNDY.PK
(3) http://finance.yahoo.com/q?s=msft&ql=1
*The writer is currently or has been a shareholder in stocks listed in this piece.
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