How you could turn penny shares into big profits this year
Stock-market volatility could mean hefty profits with penny shares. But it's not without risk, says Bengt Saelensminde. Here are three things to watch out for when buying penny shares.
Penny shares can be fantastically exciting maybe even a bit of a rollercoaster. But it's worthwhile remembering that excitement isn't the same thing as making money. In fact, just like a rollercoaster, you may end up feeling quite sick if things go wrong.
Recently, I recommended a penny share that I think has a very bright future. It's got exposure to three themes we're keen on here at The Right Side. Agriculture, oil and emerging markets... what could be better?
Agriterra (LON:AGTA) has been ticking up since I mentioned it a couple of months ago.
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But today I want to take another look at Agriterra. Because I think we can expect a good deal of volatility in the months ahead. And now seems a good timeto take a little closer look at penny shares.
I'd like to outline three reasons why you should adjust your investment style to penny shares. Because by taking these steps, you could make some very handy returns in the months ahead.
Something has nearly always gone wrong
Rarely does a company come to the stock market with a penny price-tag. If The Latest Thing PLC' came to the market at 1p it would look a lot more flimsy than ifit came in at £1. But of course that's illusory.One million shares trading at a poundare worth exactly the same as 100 million shares trading at a penny.
In fact when I invest in pre-list companies (that is businesses that hopefully will one day make it to the main market) they're nearly always penny stocks. Initial investors hope to get in at pennies and then float the business in the pounds.
Penny stocks can also cause confusion.The stocks are often quoted with many decimal places and the deal size can stretch to hundreds and thousands of shares.
So why do penny shares exist? Well, the most likely reason is that the stock has suffered a serious fall from grace. And that's exactly what's happened in the case of AGTA. Operating as an oil explorer it was known as White Nile and lost investors tens of millions of pounds.
Of course this can be very off-putting. Many investors won't consider these sorts of companies. But they are missing out on some great opportunities. And I think AGTA is one of them.
Build your positions in stages
The important thing is to keep a close eye on the company. I'll certainly be keeping a close eye on Agri's management. I'm expecting an end to its profligate spending and I want to see profits coming in by 2013 at thelatest and cashflow to turn positive.
Yes, you need to be forgiving when it comes to penny stocks but forgiveness only goes so far. You must keep a beady eye on the figures. Especially when the markets are so volatile.
Personally, I don't have a big problem with volatility when it comes to stocks. But I know that others do. When it comes to these sorts of stocks, you'll have to have a strong stomach. There's no doubt that the market makers play silly beggars with the price in the hope that fear or greed (or both) will tempt investors into making the wrong move. Badly placed stop-loss orders will almost always lock in a loss when it comes to volatile stocks.
But you can use volatility to your advantage. I like to build my penny stock positions in stages ie, when the price dips. You never know when you'll be offered a great price so you wait until the day when the market makers drop the price. I certainly wouldn't want to buy just after the price has experienced a big up move.
Take last week, notice how the price burst from its recent 2.5p 3p trading range and into the 5p area.
Though it can be tempting to jump on the bandwagon, it's nearly always worth holding off and waiting for the dip. In this case, I wouldn't want to pay more than 4p for the stock. Place a limit order' with your broker at 4p and you won't have to stay glued to your monitor waiting for the drop. Of course, there's a chance you may miss the boat... but better that than overpaying, is what I say.
And watch out for those market makers...
Watch out for rip-off merchants
When it comes to large liquid stocks there's plenty of action in the market. Plenty of buyers and sellers make for a tight spread between the buy and sell price.
But when it comes to less liquid stocks you'll find a tightly controlled market. Some stocks may only have a couple of brokers that deal in these stocks. You'll often find that the spread between the buy and sell price can be as much as 20% or more.
Two bits of advice...
First, make sure you use a decent stock broker. With these illiquid stocks it's paramount that your broker gets you a good price. A basic discount online broker may be fine for liquid stocks, but don't try and save 1% in commission only to overpay 10% on the spread.
But even when you do get a decent in-price, you can still be looking at a fairly hefty spread. And that's a cost you're going to have to absorb.
For me, that's not a problem if you're willing to take the long-view. Spread over many years, even a cost as high as 10% can be acceptable.See here fora helpful guide to online brokers.
You have to do your homework
Sure, penny stocks can be more risky so you must be convinced that you're happy with the investment over the long-run. If you may need your money within, say, a year, then I'd steer well clear of penny stocks.
Penny stocks require patience and dedication. Patience to hold back and get a decent price on the stock, and dedication to assessing the accounts. If you've got both sides covered, then there's every chance you can do extremely well from penny shares.
I've suggested AGTA as one way to go. But if you don't have the time and expertise to find the best penny shares, then look no further than Tom Bulford. He's seen outfour serious recessions and made some very good money for his Red Hot Penny Shares readers along the way. It's a great read.
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Managing Editor: Frank Hemsley. The Right Side is a regulated product issued by Fleet Street Publications Ltd.
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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.
He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.
Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.
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