Cheap Stocks – 7 Things to Consider Before Investing
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The phrase cheap stocks just sounds off to me.
There are stocks which are undervalued and are awesome companies. Now, these are stocks you will want to invest in over the long haul.
Then there are stocks that are just cheap and are cheap for a reason. These are stocks you do not want to stay married to and just need to trade for profits. When I'm saying trade I mean in and out within a few days or even the same day.
Well, in this article I will cover some of the most common questions about cheap stocks.
#1 - Can You Make Millions on Cheap Stocks?
This is a common belief amongst traders. Can I make a ton of cash trading cheap stocks?
The answer is yes and no.
Let me be the first to tell you that there has not been a Government study on the success rates of traders that specialize in penny stocks.
So, if you google penny stocks you are going to see two types of articles. The first batch of articles describes the peril of trading penny stocks. These are articles like the ones covering Merrill Lynch no longer supporting the trading of penny stocks as a response to SEC regulation on these securities.
The next group of articles are from internet trading gurus that claim they have made millions for themselves and their students.
So who is telling the truth?
I firmly believe they both are at the end of the day. However, I think one common sense trading reality keeps playing in my head. With increased volatility come increase risks.
For example, if you day trade low beta stocks, never go all-in and limit your loss to 2% per trade, you will be able to make a ton of trades.
However, trading with penny stocks, the moves are swift and strong. This level of volatility requires you to have a different level of trading sophistication as the game is moving at a higher pace.
At the end of the day, it's my belief the people that few will make it to the level of a million dollar trader exclusively trading penny stocks. The path there is faster for sure, but the journey is fraught with risks.
#2 - What is Considered a Cheap Stock?
As we mentioned earlier, you first need to decide if you are trading undervalued stocks poised for a rise or just junk.
Now, the SEC will define cheap or penny stocks as those listed under $5 dollars. However, some investors will even consider stocks under $10 dollars as cheap.
So, it's less about the price of the stock and is more about your intent. If you are looking to find the next Apple trading in 2006 before the release of the first iPhone, you are going to need a different toolkit then a momentum trader looking to ride a morning spike.
Based on this framework, what is your definition of cheap?
#3 - What are the Alternatives to Cheap Stocks?
There are so many alternatives, it can feel overwhelming.
For starters, if you find cheap stocks are not a good fit for your investment goals, you can research ETFs, which allow you to invest in a basket of stocks managed by fund managers.
You can also look into trading low beta, high float stocks which is what I specialize in. These stocks have more predictable price movements and are so heavily traded, it's much harder for one trader to pump and dump the security.
#4 - What Does the Data Show for Investing in Cheap Stocks?
As stated earlier, there is no empirical data that shows the end game for investing in cheap stocks. Again, you need skills to get into this game.
Unfortunately, any data you find is anecdotal at best. So, where does this leave us?
If you are going to test the waters in the low priced stock space, you will need to do so with caution.
#5 - What Are the Best Cheap Stocks to Trade?
Without a doubt, if you are going to trade cheap stocks, you want stocks that have liquidity. Liquidity is essentially enough volume that you can enter and exit the position with ease.
The other key element you want to look for is a stock with a good bid/ask spread. Meaning you don't want a situation where after entering a trade if you want to sell it 30 seconds later, you will lose 2% just because the spreads are so far apart.
Beyond this, it's completely up to you and your trading style risks parameters and trading experience.
Again, trading low float, cheap stocks is not something you can just jump into after watching a YouTube video. You will need to build your own rules that lay out what you do in every possible event once in the trade.
#6 - How Do You Begin Investing in Cheap Stocks with Little Money?
If you are going to invest in cheap stocks, your goal is likely for substantial games. Meaning, you are not trading the stock to make 4% return over the year.
Therefore, you don't need to invest a lot of money in order to make a decent return. Think of it like this, you can invest a $500 bucks in a volatile stock and then roll the profits into the next trade.
Please don't mistake this for saying you are going to make a million dollars starting out with $1,500. It's more of a philosophical point that you do not need to invest your nest egg in penny stocks.
You can take things slow and still turn a healthy profit over let's say 5 or 7 years.
#7 - How Do You Find Cheap Stocks to Trade?
Looking for Long-Term Investment Opportunities
Out of the two types of methods, we are going to discuss, this one requires the most work.
Cheap stocks are cheap for a reason. It's not because short traders are depressing the stock, or the company is being treated unfairly.
It's because the company is not delivering value - plain and simple. This could be due to poor leadership, too much debt or a host of other reasons.
Therefore, if you plan on holding the stock for months or even years, you need to make sure you know what you are getting into. This will require you to look at both the charts but also the companies financial statements.
To locate these undervalued companies you can use research tools such as the ones listed in this article from the balance.
Please note, that regardless of what you decide to do, you will need to test any strategies. Remember, the odds of finding the next Apple or Netflix are probably less likely than getting struck by lightning.
Looking for Short-Term Gains
If you are looking to make quick gains, which is most often the aim for retail investors you will want to use scanners and alert services to identify a list of penny stocks. Do not read an article for hot penny stocks for 2019 or 2020 and make your decision.
This is something you will need to do on a daily basis and will require you to start reviewing stocks in play before the market opens.
How Can Tradingsim Help?
Trading cheap stocks is not easy. If anyone tells you so, they are exaggerating the truth. You will need practice and lots of it.
The biggest part of trading these stocks is understanding the chart patterns. Indicators and traditional analysis methods don't always work as intended due to the volatility.
Again, this where the patterns help you focus on the big picture and not get caught up in the head fakes.
Well, Tradingsim will allow you to trade hot penny stocks at your own pace.