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Should you invest in penny stocks?

CJ asks: I recently joined Red Hot Penny Shares and I am receiving a lot of advice on which shares to buy. My question is this organisation legit? Secondly, can you recommend a few advisers who can assist me in this new venture into the share market?

Maya replies: Red Hot Penny Shares is a legitimate business but don’t get too caught up in their marketing hype because it does not fully explain the risks of the investment. You need to understand the difference between investing in penny stocks versus quality South African companies.

Penny stocks is a term that refers to smaller companies with a very low price per share anywhere from 10c to R2 per share.

It is unlikely that all small companies will turn into large ones and many of these companies may delist or go under so there is a significant risk involved that you will lose your money. However occasionally one of these companies makes it big and you have hit the jackpot. Capitec Bank is an excellent example of this.

Traders in penny stocks usually follow a strategy where they buy shares in ten companies with the hope that one of the ten will actually succeed. Also because of the low share price and low liquidity (they do not trade often) when the share price moves up it can move up in multiples: for example a 10c share can go to 20c within a few days and you have effectively doubled your money. Some traders put in an automatic sell order when the stock hits a certain price and they take the profits. The catch here is that there may not be enough buyers at that level to actually sell your shares — this is the risk of trading in shares that do not trade often.

Any investment in penny stocks should be part of your high risk portfolio and you should only invest a small percentage of your savings.

For your main portfolio you should invest in quality companies listed on the JSE. There are many brokerage houses that will assist you; it all depends on how much you are prepared to pay. If you want to make your own investment decisions you can opt for a low cost online broker like FNB Share Invest or Standard Bank Securities Online, however if you want research and advice then you need to speak to one of the brokerages like PSG Online, BJM Direct or Imara.

Read more news, blogs, tips and Q&As in our Smart Money section. Post questions on the site for independent and researched information

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Maya Fisher French
Guest Author

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