I need to address a dangerous type of security, and will do so in today’s article, which examines the differences between penny stocks vs forex. Both, however, are not investments – they are for speculators only.
Penny stocks are one of the most dangerous securities in the stock market. That’s because those stocks frequently represent shares in companies with limited, or outright fraudulent, histories.
In my 23 years of investing, I have never seen a penny stock achieve true business success that resulted in legitimate returns on investment. However, I have seen the Securities and Exchange Commission file dozens upon dozens of enforcement actions against penny stock companies.
Forex is an abbreviation for “foreign exchange”. This is a reference to the international currency markets, where traders can convert the currency of one country to that of another.
This form of trading occurs because the exchange rates between currencies are never fixed. They fluctuate, and that creates trading opportunities.
However, make no mistake – penny stocks and forex are not for the faint of heart, and should be avoided entirely by all but the most experienced traders.
What are penny stocks?
Penny stocks are officially stocks that trade under $5 per share, according to the SEC. However, they are more widely considered stocks that either trade under $2 or stocks that trade under $5 and don’t really have significant business operations.
Penny stocks are considered so dangerous that the SEC has special requirements before you can trade them, they often are not required to have any of the typical corporate governance or oversight, and may be difficult to trade because they are illiquid.
Read Also: What’re the best penny stocks?
What is forex?
As for as forex vs. penny stocks,there is an international currency market where all forms of currencies can be traded 24 hours a day. Penny stocks often trade on what is known as the “over the counter market”.
Because countries all have different currencies, except for members of the European Union, you can’t just waltz into a country and spend US dollars there. Neither can multinational companies.
Hence the need for a foreign exchange market.
Suppose you have a restaurant business based in Japan, and want to buy hummus from Israel. You must pay the Israeli company in shekels.
As a Japanese buyer, you must first exchange the equivalent value of Japanese yen into Israeli shekels.
The same is true if you want to visit a foreign country. You will not get very far if you try and us your US dollars to buy something in China. You’ll first have to change those dollars into Chinese yuan.
Now, sophisticated traders can profit from the trading of currency.
Let’s say one US dollar buys one euro. You use 100 US dollars and buy 100 euros. Over the next few months, the exchange shifts and you can only get 0.8 euros for each US dollar.
That’s good news, though. Because you have 100 euros, you can exchange those 100 euros into $125.00. You’ve made a 25% profit.
What are the differences between penny stocks and forex?
The best way to think about penny stocks vs forex is that “investing” in penny stocks is usually equivalent to buying a part of a company that has no operating results and no clear path to profitability, that is probably being run by fraudsters.
That compares to forex, which is a legitimate form of speculative trading. It’s all legitimate, but it’s speculative in that it’s gambling – because there is no way to predict exchange rates.
There’s also a big difference in terms of making a profit.
If you make any money because they your penny stocks prices went higher, it’s because you sold your shares to a greater fool, and probably because the stocks were manipulated higher by questionable methods. These are referred to by the SEC as “pump and dump schemes”.
If you make any money at forex, it’s probably because you got lucky or you know a lot about forex and how to work the market.
Penny stock profits can be had – and yes, there are some legitimate companies out there. If you do tons of due diligence and are very careful to invest only in companies with real products and honest management, you can make fantastic returns over time.
But again, that’s ONLY if the company is legitimate and becomes successful.
Forex profits tend to be much smaller because currencies don’t fluctuate that much against each other.
This chart illustrates the movement in the euro from 1999 to the present. As you can see, in 1999, one US dollar was worth 1.1553 euros. Today, one US dollar is worth 1.1318 euros.
Advantages of Penny Stocks
When it comes to selecting penny stocks vs forex, here are the advantages of penny stocks. However, be advised, this only applies to penny stocks that are legitimate businesses.
- Potentially high levels profit
- Inexpensive on an absolute basis
- Arriving early in the story
Here’s a video that gives additional information on investing in penny stocks, and how to find fraudulent penny stocks.[embedded content]
High levels of profit
The primary reason I like small cap value stocks is that they historically have the best performance over time compared to all other asset classes. That’s because a company that is smaller has more room to grow than a big one.
That makes sense, of course. A company with a $100 million value could return 1,000 times your investment if it became a $100 billion business.
Don’t believe me? In 1996, Apple was worth less than $3 billion. Just recently it was worth over $1.1 trillion – a 370-fold increase in value.
If you get into a legitimate penny stock company, and it becomes a real business, those shares you bought at $0.50 could increase by factors of 100 or more – BUT that is very very rare.
Read Also: Where is Apple’s stock predicted to go?
Inexpensive on an absolute basis
So if you look at a $1 stock, compare it a $100 stock, and say the $100 stock is “more expensive”, that’s only true if you compare them on a per-share basis, or an “absolute basis”.
On a relative basis, you could buy 100 shares of the $1 stock and 1 share of the $100 stock and still have invested the same amount of money.
The advantage of owning stocks of differing prices on an absolute basis is that you can buy more shares of a cheaper stock.
Using the example above, if you buy 100 shares of a $1 stock and that stock runs up to $1,000 per share, you will make $100,000.
But if you buy one share of a $100 stock and it goes to $1,000 per share, you will make $9,900.
Arriving early in the story
I think of all companies as businesses that tell a story. The world had a problem. This company came along with an idea to solve that problem, and a business grew from it.
The story for a company like Apple will take a very long time to tell, and if you are researching the company as a possible investment, you will need to research a long time to learn about Apple’s full story.
The story for a legitimate penny stock will be shorter, one that is easy to understand, and you may even be able to contact management directly to hear even more of the story.
Thus, as the company grows, you will have a much easier time seeing if the story goes off the rails and thus raise warning signs, or vice-versa.
Advantages of forex
There are a few advantages when it comes to penny stocks vs. forex to the point that you don’t have to throw out forex as a possible security to investigate. Consider these advantages:
- Operates as a portfolio hedge
- A place to park excess cash
- Flexibility with trading
Here’s a video that gives good information of forex trading and scams to look out for.[embedded content]
What happens when companies do business overseas, especially if they do a lot of business overseas? Won’t their financial results be affected by currency changes?
Yes! Many famous companies must do business in foreign currencies because they have an international presence. Thus, those currencies can be strong or weak against the US dollar.
When strong, it requires more foreign currency to exchange for a US dollars, which means currency-adjusted results may lower earnings expressed in US dollars.
While many companies engage in complicated hedges to blunt those effects, you can, too.
Forex trading permits you to hedge against stronger currencies to offset dampening effects.
Park your cash
It’s not always a good idea, but if you have excess cash and you think a foreign currency will weaken against the dollar while you hold that cash, you can park your funds in foreign currency and hope for a better exchange rate when you need it again.
There are 180 currencies recognized by the United Nations. You can select any currency you want, or even switch among several, if you are aggressively attempting to profit by forex trading.