# Rule of thumb: avoid Aussie penny stocks < $1 - Is this advisable?



## helpme (4 April 2017)

I developed a rule after making some observations. I would like the experienced investors here to advise.

Is it a good rule of thumb to avoid Aussie penny stocks <$1? Put them under the radar only after they are trading above $1. Do you think this makes sense? Will such a rule cause an investor to lose too many opportunities in the Australia stock market?

I find penny stocks generally too volatile and illiquid.


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## luutzu (4 April 2017)

helpme said:


> I developed a rule after making some observations. I would like the experienced investors here to advise.
> 
> Is it a good rule of thumb to avoid Aussie penny stocks <$1? Put them under the radar only after they are trading above $1. Do you think this makes sense? Will such a rule cause an investor to lose too many opportunities in the Australia stock market?
> 
> I find penny stocks generally too volatile and illiquid.





Nope.

What if the company is worth over $1 a share but is selling for less?

What if its market cap is hundreds of millions but its share price is less than $1 due to high number of shares. Or, what if its share price is over $1 but its total market cap is only a hundred mill or less?

So while avoiding penny dreadful, favouring more established businesses, is generally less risky... it all come down to understanding the business, try to see what the future holds for it and whether or not the current value with that future possibility compare to the current market price etc. is worth an investment.

One can buy into big, established bluest o the blue chips and it still could crash. 

The future do not guarantee anything. Hence, "smart" monies who uses other people's money spend all their time diversifying the crap out of capital entrusted to their "expertise" - can't guarantee future performance doesn't mean you cannot guarantee where the blame will land: "The market".


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## helpme (4 April 2017)

Thanks. However, would you advise newbies to keep to this rule?

Although blue-chips can crash, they do not crash so quick and so hard until there is no time to react. It is very rare to have a blue-chip crash >15% in a single morning but much more common for penny stocks to do so. Having said that, I was recently burnt very badly by DOW which crashed >25% in one single morning. Have not given up on stocks yet.



luutzu said:


> Nope.
> 
> What if the company is worth over $1 a share but is selling for less?
> 
> ...


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## pixel (4 April 2017)

helpme said:


> I developed a rule after making some observations. I would like the experienced investors here to advise.
> 
> Is it a good rule of thumb to avoid Aussie penny stocks <$1? Put them under the radar only after they are trading above $1. Do you think this makes sense? Will such a rule cause an investor to lose too many opportunities in the Australia stock market?
> 
> I find penny stocks generally too volatile and illiquid.



Volatile they may be, but volatility can be a Trader's friend.
It all depends on your trading style, knowledge, discipline.
But even for long-term investors, there is no hard-and-fast rule that separates the "good" from the "bad" stocks. If you want to buy shares as a secure investment, the Market Cap (number of shares on issue times current share price) has more weight than price alone. And of course the skills of your Management Team, financial stability, ...
If Trading is more your interest, Technical Analysis, applied with knowledge and discipline, will work equally well across all price ranges. It is arguably even more rewarding in the lower range of true *penny* stocks because of the frequently much higher Average *Relative *Trading Range.


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## helpme (4 April 2017)

Volatility may be good for trading but volatility without liquidity is very dangerous. Australia penny stocks lack liquidity. Perhaps U.S penny stocks may be better for trading than Australian counterparts due to the higher liquidity.



pixel said:


> Volatile they may be, but volatility can be a Trader's friend.
> It all depends on your trading style, knowledge, discipline.
> But even for long-term investors, there is no hard-and-fast rule that separates the "good" from the "bad" stocks. If you want to buy shares as a secure investment, the Market Cap (number of shares on issue times current share price) has more weight than price alone. And of course the skills of your Management Team, financial stability, ...
> If Trading is more your interest, Technical Analysis, applied with knowledge and discipline, will work equally well across all price ranges. It is arguably even more rewarding in the lower range of true *penny* stocks because of the frequently much higher Average *Relative *Trading Range.


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## luutzu (4 April 2017)

helpme said:


> Thanks. However, would you advise newbies to keep to this rule?
> 
> Although blue-chips can crash, they do not crash so quick and so hard until there is no time to react. It is very rare to have a blue-chip crash >15% in a single morning but much more common for penny stocks to do so. Having said that, I was recently burnt very badly by DOW which crashed >25% in one single morning. Have not given up on stocks yet.




I think the rule is trying to avoid small companies and favour the more established ones.

In that sense, maybe other measures are more appropriate than the share price. Such as the market capitalisation [share price times number of shares outstanding].

Personally, I'd go for the company's Sales [revenues] as a measure of its size rather than the share price.

Share price can, and do, get manipulated by management. They tend to dilute or consolidate the number of shares to keep the share price within a range they think the average investor and fund managers believe is "reasonable" or indicative maturity or stuff like that. So a $100 a share seems "expensive" while those under $1 seems "risky" and new upstart.

So a bank might be more reasonable if its share price is in the 30s; an engineering around $10s, say. 

But yes, I think it generally is preferable to invest in more established companies rather than the riskier small companies. But I wouldn't have any hard and fast rule... just trying to understand the business and its approximate value.

Though small companies tend to be more neglected and so might present good opportunities. But as you know, it come with massive risk of the business going under if a few bad luck hit it. 

But to buy into big companies so that if it does crash, it'd crash slower and thus giving more time to get out... that might be buying high to sell low. Best to know the business properly so that such opportunities can be taken advantage of rather than it screwing us.


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## skc (4 April 2017)

It's not a bad rule if you want to avoid the majority of the smaller end of the market... however it's really a rule for the greenest and laziest of investors.

Other's have already posted that market cap is what determines if a stock is a "penny stock", not the share price. And really, when the share price of a real "penny stock" goes >$1 it is probably more risky to buy then. MJP and SCU are two recent examples that comes to mind.


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## barney (4 April 2017)

helpme said:


> Thanks. However, would you advise newbies to keep to this rule?




As Luutzu has eluded to ... the $ value of a Company has little to do with whether it should be traded or not.  You obviously mean Company's with small Market Caps/Specs, which can be difficult to trade. 

The Volume of shares traded is generally a far better "indicator" of a Company's suitability to trade especially in the Spec end of the market.

In essence, a newbie trader is likely better off not trading at all but that is a whole other issue. If you go in boots and all too early you need to be prepared your boots are likely to get dirty

PS Been away and posted not realizing SKC had already posted ..... the vibe is along the same lines.


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## galumay (4 April 2017)

You ask about investing, but then talk more about trading. From an investing perspective neither voalitilty nor illiquidity are of themselves a negative indicator. Some of my best investments have been very illiquid, quite volatile and under $1. I simply dont think you can generalise in this way.


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## OmegaTrader (4 April 2017)

helpme said:


> I developed a rule after making some observations. I would like the experienced investors here to advise.
> 
> Is it a good rule of thumb to avoid Aussie penny stocks <$1? Put them under the radar only after they are trading above $1. Do you think this makes sense? Will such a rule cause an investor to lose too many opportunities in the Australia stock market?
> 
> I find penny stocks generally too volatile and illiquid.




1) volatility: Can be controlled by position sizing and gearing.
eg Putting 1% of capital into a volatile small cap will reduce volatility significantly and potential returns of course.

Say stock falls 50% with 1% invested would mean only a .5% loss.

Conversely a highly geared instrument trading the equity index could have massive volatility even though the underlying index may move .5 -1%

etc etc

2) Liquidity is a case by case basis.  Unless it is really bad or you are really big..... 

I think the point of the rule of thumb is to stop new players to over-commit themselves to risky investments and blow up their account. I think it is a good rule for people who want to passively invest and 'take it easy'. Those people generally have limited knowledge/time and are busy working etc

 But for people trying to outperform the market this would be cutting off opportunities to find value investments or to find short term trades.

Will it cut off too many opportunities.. Depends on the strategy I can't answer that.


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## helpme (4 April 2017)

Great answer. I guess for retail investors with full-time jobs, they'd better stick to this rule. For professional investors with more time on their hands, sticking to this rule may lead to loss of opportunities. 



OmegaTrader said:


> 1) volatility: Can be controlled by position sizing and gearing.
> eg Putting 1% of capital into a volatile small cap will reduce volatility significantly and potential returns of course.
> 
> Say stock falls 50% with 1% invested would mean only a .5% loss.
> ...


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## Quant (4 April 2017)

Key to trading and investing for that matter is a method , Specs are ok for gambling small amounts but generally arent safely scalable beyond certain position sizing . Big picture i think they are a dead end but thats just me . Look for basing pattern over a decent time frame thats got a volume breakout on preceding rising volume pre break  , thats how id play em if i did , i know of successful spec traders and thats all they do   ..    Be aware many blue chips over years have traded sub 1 dollar  , MIM comes to mind , one of my faves back in the day  , so they arent all Specs


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## helpme (4 April 2017)

Thanks for your insights. I have read about this basing method several times. It may work well in the past but may not work well in today's markets given that it is quite well-known today.



Quant said:


> Key to trading and investing for that matter is a method , Specs are ok for gambling small amounts but generally arent safely scalable beyond certain position sizing . Big picture i think they are a dead end but thats just me . Look for basing pattern over a decent time frame thats got a volume breakout on preceding rising volume pre break  , thats how id play em if i did , i know of successful spec traders and thats all they do   ..    Be aware many blue chips over years have traded sub 1 dollar  , MIM comes to mind , one of my faves back in the day  , so they arent all Specs


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## Quant (4 April 2017)

helpme said:


> Thanks for your insights. I have read about this basing method several times. It may work well in the past but may not work well in today's markets given that it is quite well-known today.



There are no absolutes but the guys i know still do it to this day , dont guess just  go find evidence . DO some work , no effort = no reward . Probability is basically your only ally , without it you are just gambling blindly  .  Prove it works or doesnt work , then you got something  . Statistically based rules based emperically proven evidence will set you free , it involves work  and cognitive output . The only person you have to convince is yourself  ... get to it


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## armchair (29 October 2017)

I did some research into this and posted the tables and charts on my blog: https://investai.com.au/should-you-avoid-stocks-worth-less-than-1/

If your intention is to hold for the long term then the answer couldn’t be clearer, you should avoid stocks with a share price of less than $1. The median total shareholder return for stocks trading over $1 is positive, whereas it’s negative for stocks trading under $1. This holds true for investment time-frames of 1 year, 3 years, and 5 years.

If you look at the tables on my blog post you'll see that I also calculated the _average_ return  (cf. median). Averages get distorted by outliers (i.e. a handful of stocks that yield massive returns). But it's these occasional outliers that tempt traders into so called penny dreadfuls. If your objective is to smash it out of the park you’re more likely (although still unlikely) to do so with sub $1 stocks.

In summary the rule of thumb has merit. If this is the only thing you're going to look at (not that anyone would look at only this) but if it was, you should do OK over the long term by only buying stocks trading at more than $1. And if you're looking for a big win, you'll increase your (albeit slim) chance by picking stocks trading at less than $1.


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## Miner (29 October 2017)

armchair said:


> I did some research into this and posted the tables and charts on my blog: https://investai.com.au/should-you-avoid-stocks-worth-less-than-1/
> 
> If your intention is to hold for the long term then the answer couldn’t be clearer, you should avoid stocks with a share price of less than $1. The median total shareholder return for stocks trading over $1 is positive, whereas it’s negative for stocks trading under $1. This holds true for investment time-frames of 1 year, 3 years, and 5 years.
> 
> ...



Yeah
I followed the 'rule' avoid shares less than $1. So when S32 was below $1 I avoided buying it and now it is too expensive to buy it. Same happened with GNG shares. On the otherhand I bought RCG at much over $1 because all those experts and stockinvalue calculation was suggesting RCG is a value share now it is struggling to go pass 85 cents. I am scared to buy RCG again because its price is much below $1. 
Most of the stocks are traded at 20 cents through IPO. So what should I do ?
In short, blanket rule avoid below $1 need to be supported with much more story lines.
My Two cents (reject it as it is below $1) .


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## skyQuake (29 October 2017)

armchair said:


> I did some research into this and posted the tables and charts on my blog: https://investai.com.au/should-you-avoid-stocks-worth-less-than-1/
> 
> If your intention is to hold for the long term then the answer couldn’t be clearer, you should avoid stocks with a share price of less than $1. The median total shareholder return for stocks trading over $1 is positive, whereas it’s negative for stocks trading under $1. This holds true for investment time-frames of 1 year, 3 years, and 5 years.
> 
> ...




The median is good statistically but horrible practically. If you hold a portfolio of stocks you'll get the average return not the median return. The massive outliers are often what makes or breaks the portfolio esp in small caps town - the asymmetric risk/reward is often why people trade the small crappy end of the market

Having said that the stats seem bad regardless...
Played around with Oct 2016 - now. Added in a turnover > $x filter to avoid untradable stocks
Avg 8.4%, median -13.1%
Performs worse than the index and probably carries a lot more risk not to mention liq issues. Definitely one for traders rather than investors


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## armchair (30 October 2017)

skyQuake said:


> The median is good statistically but horrible practically. If you hold a portfolio of stocks you'll get the average return not the median return.




Well it all depends. It's a tricky subject, but the median tends to be a better indicator of the typical when there are outliers in the data. Perhaps check this out: https://www.quora.com/When-should-one-use-median-as-opposed-to-average


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## skyQuake (30 October 2017)

armchair said:


> Well it all depends. It's a tricky subject, but the median tends to be a better indicator of the typical when there are outliers in the data. Perhaps check this out: https://www.quora.com/When-should-one-use-median-as-opposed-to-average



I get what you mean, but it all boils down to *can you ignore the outliers*.
Stock returns have fat tails, so a normal distr falls short. A single outlier can shift your portfolio from mediocrity to stardom.


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## brty (31 October 2017)

Using average statistics at the small end of the market to define what is happening, totally misses the opportunities. Currently the spec end, not only less than $1, but less than 10c is doing fantastically well, provided you sort the wheat from the chaff.
Basically use some FA with solid TA to help eradicate the real no-hopers from those with a good chance. Probably 70%+ of the small end are real dogs, but with enough practice and experience it eventually begins to get easier to narrow the field, but you need to specialise in a field.

My forte is in the junior resource sector. From a few drill holes it becomes easier to tell what has no hope from those with a chance of success. Also look for a booming sector/commodity to concentrate on, the cheapies in lithium right now with the slightest sniff, are tending to boom. 
I don't know the techs, so don't play with them at all.
I look for liquidity, low market cap relative to potential resource, plus lowish number of shares.

Of course as some have pointed out, liquidity can dry up in a downturn very quickly, so the time to play the spec end is when it is running, but stay away at other times. Again experience over many years comes into play. You can't teach experience....


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## tech/a (31 October 2017)

Agree brty

Can be great for trading experience and some real beer money.
I strongly advise it for both 

I look at the small end of town like trading the movements of a fly
The big end is more like Hippos and Elephants. Big money I prefer minimal shocks so ASX 300 for me. 

But don’t walk away from opportunity


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