Why Penny Stock Players Rarely Get Rich

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Why Penny Stock Players Rarely Get Rich

We’re all heard the stories about people getting rich in penny stocks. There’s always the one guy living two blocks away that made a million dollars off one. Of course there’s your neighbor who knows somebody who knows somebody whose cousin made a couple of million off a penny stock.

Everybody dreams of hitting the big score, be it the lottery, an inheritance or a penny stock. If you play the pennies, then you’ve dreamed of hitting the big one too; your favorite stock running to $1, $5 or even $10 a share and making you rich. You know you’ve indulged so don’t deny it.

However you’ll probably never meet anybody that got rich from a penny stock because it rarely happens. It’s only a dream, albeit a deliciously enticing one.

It’s possible to make good money in the pennies but it’s nearly impossible to become wealthy in them. There are just too many factors working against you.

Before we go further, we should define “rich”. Would you be rich if you made a million dollars in the market? Everyone’s numbers would be different, but I’ll pick a million since if you lived frugally you could stop work. Putting a million in a savings account at 6% for example would yield $60,000 a year uncompounded. You could live on that but you couldn’t buy a lot of expensive toys. With interest rates today, you’d get probably somewhere about half that, $30,000, maybe $40,000.

With our living standard today, I suppose an argument could be made you aren’t really rich even if you have a million in cash. You certainly wouldn’t be able to stop work and do anything you pleased. A million in cash is more money than most of us have so we’ll go with that number.

Once you see how difficult it is to make a measly million, you’ll understand why almost nobody becomes truly wealthy from a penny stock. We’ll define “truly wealthy” as $5 million. With that much cash, you could retire and do just about anything you wanted within reason.

So what makes it so tough?

1. From 7000-8000 penny stocks, you have to pick one out of only a very few which will dramatically increase in price. It’s the same as looking for the needle in the haystack. The odds are already heavily against you before you even make your selection.

2. You have to spend a considerable amount of money buying a large block of shares in the stock you’ve selected. How many of us have a spare $20,000 for example to spend on a penny stock? Not many I think. If you don’t have the cash then you’re eliminated already.

3. You have to be the type of person that’s willing to risk large sums of money on a shaky proposition. Not many of us are willing to wager $20,000 on any bet, even one with the odds in our favor; forget plunking down that kind of cash where the odds are heavily against us. Most of us are eliminated at this step, even if we have the money. As they say with the lottery, you have to buy a ticket to win. You must also have ice water in your veins. As you watch the PPS climb and your profit increase, the more stress you’ll suffer and the higher the pressure you’re required to endure. Deciding whether to hold or sell can become excruciating, especially so if your family and friends are following the action.

4. Even without external pressure from other people, taking a large profit is almost irresistible to most folks. When they start thinking what they can do with that money, most will sell when they have a huge profit. They won’t or can’t wait for the stock to climb where they will hit the really “Big One”.

We’ll run through a real case with FRPT to demonstrate how much money you could have made. FRPT was a stock which would have produced a nice profit if you had thrown some big bucks at it.

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Why Penny Stock Players Rarely Get Rich

FRPT popped-up on the scene in 2005. It was never a sub-penny stock or even under a dollar so you couldn’t have bought millions of shares. Finding it wouldn’t have been easy. In 2005 - early 2006, it was just another penny stock trying to make it to the big time. There was hardly anything about the stock which would have caught your eye, so you wouldn’t have had any reason to think it would move very much. Sinking a lot of cash into FRPT in 2005 or early 2006 would have been purely a roll of the dice.

However, I suppose there would have been a few people who would have taken a chance and you were one of them. You buy 10,000 shares at $2 a share in early April 2006 (Point A on the chart below). That’s twenty big ones you now have riding on FRPT.

In May the company receives a government contract. By August the PPS is about $7.5 per share. In late September 2006, the PPS hits about $9 a share (point B). In five short months you are now showing a profit of $7 a share for a total profit of $70,000. Most folks here I think would sell but let’s suppose you hold. The wife or husband is probably urging you to sell already.

Oh oh! The price starts dropping. By November the price is down to about $7 a share (Point C). Your profit has dropped to $50,000. You just lost $20,000 in about a month. What do you do now? Decisions, decisions! A lot of folks would sell here if they hadn’t already. The pressure is building but you decide to hold.

The price skyrockets and a couple of weeks later in December 2006, the price is sitting about $16 a share, (Point D). Now you have a $140,000 profit. That’s a lot of money! Can you continue to hold and take a chance the stock may drop on you again?

The price continues to move up where in early January 2007, it’s now at about $22.50 (Point E). Now you have a $205,000 profit. Your family if they’re watching would be on you 24/7, with a hundred different reasons why you should sell. Could you really resist selling here? Let’s say you hold.

Again the stock begins to decline. Every day is pure agony. By March it’s down to $15 a share (Point F). Your profit is now $130,000. You lost $75,000 by holding. Most people would be tearing their hair out now. Will it continue to drop or turn around again and go higher? After watching a 75 thousand-dollar drop, I think most folks would sell here. Do you take your $130,000 and scamper or go for more?

Then additional good news arrives, more government contracts. The stock turns around and starts climbing again. By June, the stock sits at $30 a share. Your profit is at an all-time high, $280,000! “How much higher can this thing go?” you wonder. I think at this point, for sure, anybody that had originally bought shares at $2 would have sold. $280,000 is just too much cash for most people to turn down, IMO. That was the most you could have made in our example, since FRPT started dropping soon after it hit its high. It’s trading around $3 today.

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Why Penny Stock Players Rarely Get Rich

It was about fourteen months from when you first bought the stock in April 2006 until you could have sold at $30 a share, in June 2007. Fourteen months is a long time to watch a stock. We didn’t cover each point in the chart but there are many places it dropped before moving higher. How many of us could have held until $30 a share before selling? Not many I think.

Even if you had followed our example to the letter you wouldn’t have gotten anywhere near our goal of a million big ones. In our scenario, to make $1,000,000 you would have needed about 36,000 shares. (36,000 x $28 per share profit = $1,008,000). At $2 a share your original cost would have been $72,000. Only crazy people and clairvoyants sink that kind of money into penny stocks. Certainly, retail players like most of us on HSM don’t.

Let’s say though you indeed did put $72,000 in FRPT in April 2006. At point B you would have had a profit of $324,000. At point C your profit would have been $252,000, point D $576,000, point E $810,000, point F $540,000 and point G $1,008,000.

As far as I know there’s no data which reveals what investors have done in real situations, so let’s take a poll. Please send me a PM and specify which profit level you would have sold at. You can use either example, where you started with $20,000 or $72,000. If you wouldn’t put $20,000 into a penny stock, please still answer the poll.

For the second example above, be realistic. Don’t say since you knew the stock would generate a million-dollar profit, you would hold until then. Assume you don’t know how high the stock will increase. I’ll compile the data and post it here in a couple of weeks. It’ll be interesting to see what everybody says.

What are the chances of getting rich off a sub-penny stock? Let’s say you find a penny stock at .0050 and buy a million shares. Your cost is $5000. If it moves to $1 a share, your profit is $995,000!

The problem is that I don’t know of any sub-penny stocks at .0050 that have ever reached a dollar. Secondly, the stock will take months or longer to reach that level. It will be decreasing and rebounding all along the way just as FRPT did. Every day you will debate whether to sell or not. Penny stock players know sub-pennies at .0050 don’t run to a dollar a share. I think most folks would sell long before they even got anywhere near a $200,000 profit.

How about the lowest of the low, a sub-penny at .0001? If you buy one million shares at .0001, your cost is $100. If the stock goes to $1 a share, you’ve made your cool million!

Again, I don’t know of any stock at .0001 that has ever increased to a dollar. I have never even heard of one. You’re also faced with the same hold or sell decision as the PPS increases. It’s a long climb from .0001 to a dollar. It might take two years to move to a dollar share. I just don’t believe many folks could refrain from selling until the stock hit a buck a share.

I’ve probably insufficiently conveyed the range and intensity of emotions you will experience as your profit begins to reach astronomical heights. Have you ever had $500 or $1000 invested in a penny and watched it run? You have a 20% profit … 30%... 50%... 100%... 120%... 150%... 200%...

Recall the emotions involved as you watched the stock climb higher and higher, not knowing what it might do in the next few minutes and debating whether to continue to hold or sell. Consider how you would have felt if you’d had $20,000 or $72,000 dollars riding on the stock instead of $500 or $1000.

The odds of picking the right stock are infinitesimal. The chances of any stock increasing as in our examples are small. Many of us don’t have the cash to risk gambling large amounts on penny stocks; and if we did, we wouldn’t do it. As our profit climbed, the pressure to sell from external sources, family members perhaps, might eventually become unbearable. When we reached a profit in the range of $100,000 - $200,000 for example, our own urge to sell could become irresistible. Add the stress involved and most of us would take the cash and run long before we had the opportunity to make a million on the stock.

That’s why I think only rarely does anybody get rich in the pennies.