Blog : 10 Trading Myths (#7 - 10)

by Peter Leeds on February 3rd, 2015

You can see Trading Myths #1 - #2 here.

You can see Trading Myths #3 - #6 here.

#7.  It's Not Like The Commercials Would Have You Believe

The second I execute this trade, my shares will be purchased.

Just because you click "buy" doesn't mean that your penny stock or mutual fund will be purchased at or even anywhere near that particular moment in time.

Sometimes, especially during heavy trading periods in the markets, or as a result of computer problems, your online order will be processed minutes or even hours later. As well, many of the online discount penny stock brokers need to review your order before routing it to the exchange.

As a result, the price of the penny stock may have changed by the time your order hits the market... for better or worse.

#8. Up, Up, And Away!

If I trade online, I can get in on all those high-flying IPO's!

Initial public offerings consist of the shares of publicly traded companies that are being offered for the first time to investors. Because the price often rises rapidly in early trading, they have become very popular in recent history.

However, part of the reason for first-day share spikes is related to the feeding frenzy created by the difficulty in acquiring shares (rather than the merits of the penny stock).

As well, the limited supply often means that many small-time traders get left out in the cold despite their best efforts. Even though some online brokers are taking steps to get more IPO shares to individual investors, many traders will find it difficult or impossible to "get in on" a hot IPO in which they are interested.

Typically, IPO's are distributed before their release to institutional investors, and others funding or owning the company.

#9. I Think I Just Bought A Lemon

Some traders think that the price to earnings ratio will tell you whether a penny stock is cheap or expensive.

To some degree this holds true, but too many external factors also have to come into play. For example, a company could have made a one-time asset sale, and have a creative accountant, making it look like their earnings increased (and thus improved their P/E).

While the number would not be based on normal operations, it would not reflect the corporation's earnings power. In fact we are reminded of a specific example to demonstrate the point:

IIGP was a poorly run penny stock, losing about $10,000 a day after income and expenses. However, through a $6 million asset sale on their books as earnings, their P/E showed as 2.5 for a while. An uninformed investor may think this penny stock was a bargain, when really it was a dog.  (Or Pig... IIGP, am I right, people?)

As well, a 'good' P/E ratio depends on the specific industry the penny stock company is involved within, the market environment, investor sentiment, and other factors. It also does not factor in concepts like earnings growth, technical analysis patterns, future operations, etc... Therefore, the P/E ratio is only a small piece of the puzzle.

#10. Roll The Dice: Part II

You must assume high risks to make good money in the penny stock market - is a myth.  This myth often forces investors to accept higher risk levels than they would otherwise be able to tolerate.

Penny stock investing is one of the best avenues the average person has of accumulating substantial wealth. And it really doesn't have to be very risky. True, usually higher risk investments mean higher potential rewards, but it is an imperfect ratio.

In fact, out of any two penny stocks, one will always be a superior investment once the risk/reward ratio is factored in. Some industries can suddenly become 'riskier' (i.e.-military technology if the government cuts back military spending) without a subsequent increase in the potential rewards.