Why you should avoid penny stocks

The two questions I am asked about the most by people on the streets, in the grocery store and even stuck in traffic next to each other, are:

  • Should I be invested in penny stocks?
  • Should I be invested in the Iraqi dinar?

I always answer those two questions in just about the exact same way:  Hell no!  Do not invest in penny stocks!  Do not invest in the Iraqi dinar.  Today’s column is about why you shouldn’t ever trade penny stocks. Tomorrow I’ll explain why the “buy Iraqi dinars before the coming revalutions” is a stupid scam.  Let’s talk penny stocks for now though.

A couple years ago, I got a call from a buddy of mine who said that ZZ Top was going to be playing at the Beacon theatre in NYC and that Billy Gibbons and his wife were fans of mine from my TV show and that they wanted to meet me.  And the night of the concert, I got to hang with Billy backstage before the show and then got to drink beers and even jam on his Les Paul after ward on the ZZ Top tour bus.  Billy talked a lot about how great the Inn of the Mountain Gods in my home town of Ruidoso is and his wife who was also very cool, mainly grilled me about stocks, including several penny stocks that she owned.  I told her to sell them all immediately.

I checked on the only  one whose symbol I could remember when ZZ Top came back through my hometown this past week. It was down from 17 cents to 0.05 cents. That is, 1/20 of one cent. Down from 17 cents. More than a 90% drop from that 17 cent level where “it just can’t drop much further than that can it”?

The very same day after checking on that doomed penny stock of hers, I was answering the flurry of questions by the guy sharpening my chain saw the other day after he recognized me as a “financial expert from TV” and the discussion quickly turned to whether or not he should start trading “penny stocks to make a fortune. I see all these people making tons of money trading penny stocks.  Shouldn’t I be doing the same?”  My short answer was: Please, don’t ever trade a stock that’s below $5 per share.  David explains why in this absolute must-read for every body who’s ever been tempted by those ads you see on Yahoo! Finance and elsewhere about trading penny stocks.

Please read this article about why you should never invest in penny stocks if you own any penny stocks or are thinking about ever trading penny stocks.

On Penny Stocks – Some key quotes from David in the article:

I am often a fan of neglected small cap stocks.  When I find a good one, I add it to my portfolio.  But I am generally not a fan of stocks that trade below $1.00.  Why?  Because there are many promoters of the stocks who deceive those who are illiterate regarding the markets, promising big gains, but end up delivering significant losses.

I see lots of penny stock ads.  Big deal. But one ad got under my skin.  This article was motivated by an ad that said, “Penny stocks made me rich.”  Now, there may be a handful of people for which that is true, but in general, those that invest in penny stocks lose money.

There is a constant in investing, that amateurs who invest in volatile asset classes tend to lose money, and more money as the asset classes get more volatile.  Penny stocks are volatile in the extreme.  Even leaving aside the promoters who pump-and-dump, it is a rare person who can approach these in a businesslike manner.

I don’t know exactly why there’s so much correlation between the fact that it’s almost always people who know me from TV that ask about the penny stocks and/or the Iraqi dinar. Other folks, like my readers on Marketwatch and of my articles in the FT, WSJ, and so on, write me questions about Apple or Google or the broader economy. Regardless, the point is, that everybody needs to know two very simple rules of investing:

Don’t trade penny stocks. And don’t buy into the Iraqi dinar scam. More on the latter one tomorrow.