Penny stock investors rejoice! For years I have heard about penny stock investors being inexperienced traders that aren’t as educated or knowledgeable about the market as our mid to large cap peers. We don't use limit orders, we send share prices all over the place, etc.
I think the last couple weeks of trading may have evened the field a little. In fact, everyone’s favorite Nebraska billionaire, Warren Buffet, called the recent market turmoil, “an economic Pearl Harbor.” And I'm pretty sure he wasn't thinking about penny stock traders.
Many economists believe that investors make decisions rationally, weighing up corporate data and other pricing signals to evaluate gain or risk before buying or selling stocks. But this idea is now under attack after this month’s global stock slide.
I was reading an article recently that explained how science has unveiled the hidden drivers of stock bubbles and crashes. Theorists of behavioral or emotional finance say conscious decisions are just the tip of the iceberg. A boom-and-bust event, they contend, follows a distinct path.
At first, investors are skeptical about stepping into the market. When they see their peers getting rich by buying a given stock, they cautiously make a purchase and their confidence builds as the stocks value climbs.
The gains fuel enthusiasm, which leads to the euphoric conviction that this is an easy way to make money! Sadly, euphoria leaves investors indifferent to warning signs. When the share price starts to wane, investors remain confident that that the stock will trend higher and there is no need to actually sell the stock.
As prices slip further, fear sets in, and then, suddenly, panic. Defeated by their loss, investors decide to never invest in stocks again.
One way to avoid bursting the bubble, said one behavioral analyst, is to think less about the intrinsic value of a penny stock and more about the perception of its value.
“Short-term volatility is created when you have people running after each other,” he said. “If people stopped chasing what they think the other person is thinking, the volatility would disappear.”
Fear not though. Market volatility isn’t always your fault. A researcher at Cambridge University says market fluctuations are amplified by hormones. During the halcyon dot-com days, he was, he says, stunned to see male traders “displaying classic symptoms of mania.”
Quitting finance and heading to Cambridge, he tested his theory. He took saliva swabs from 17 male traders at a London stock-dealing firm twice a day and measured the samples for two hormones: Testosterone, which encourages confidence and risk-taking, and cortisol, which is used by the body to deal with “fight or flight” emergencies.
When the traders were in profit, their testosterone levels surged. When they were in loss, or in fluctuation, it was their cortisol that rose sharply.
“If you were to take an identical set of facts and present them to someone high on testosterone and someone who’s got chronic cortisol, the first one would see opportunities everywhere and the second would see nothing but risks,” he said.
The cure for the common burst bubble could be as simple as having your wife or grandfather at your side. Women and older men add a calmer, longer perspective to the headstrong, testosterone-driven actions of young male colleagues.
Now, as a penny stock investor you may not trust the university results of a biochemistry researcher… or even want your wife or grandfather to help you in the investing trenches.
And the investing trenches are where most penny stock companies are right now. Yes, most deserve to have their stock certificates rot there in the mud, but not all. The fight or flight tendencies that help us avoid swimming with sharks can also erroneously kick in and see us run at the wrong times.
Our inability to see things clearly has nullified our ability to judge penny stock companies based on their proper merit. Instead, we’ve developed a herd mentality, leaving all speculative companies, good and bad, in the gutter as investors run for cover.
Go back and look at the penny stock company you were considering earlier this week or even last week. Is it a fundamentally strong company in a niche market with massive upside potential? Are investors treating this company any differently than a debt-ridden, dead growth company in the middle of a massive cash crunch? Probably not.
While others flee, you could decide to fight. Except in this case, there isn’t really much of a fight. Millions of investors are running for the exits, tossing their penny stock shares out the window. If you like a penny stock others are discarding, it’s more like cherry picking.
