I get it. When someone tells me about stocks under 10 that could go all the way to $100 a share, I get it. It’s difficult to not get incredibly excited about the potential to make your money ten times over. I mean, who would say no to that?
Just looks at some of the most popular stocks out there. Maybe the reason people get so excited when they hear about the top stocks under 10 is that they have seen that story before. Stock is at $8 a share and goes to $800. Where do I sign up?
I know what you are thinking. Who in their right mind would pass on such an opportunity? All the way back in 1997, Amazon was trading clearly under $10, and at $1.37 to be exact. Now, I was not trading Amazon back then when it was just a bookstore, but if we were to have bought just 100 shares of Amazon back in 1997 for the cool price of $1.37 a share (it would have cost us $137 to do this), we would now be on our very own private island sipping champaign because our initial investment of $137 would now be worth $99,578.
Even better, if we simply invested $1000 into Amazon is 1997 (rather than just $137), we would have been able to purchase 729 shares which would now be worth a cool $725,923.62.
Almost three-quarters of a million dollars is a lot, but where else are you going to get a return like 72,584.67% over twenty years???
So I get it. This type of opportunity makes everyone and their mother looking for these stocks under 10 with the potential of an Amazon, or an Apple for that matter.
Just like in the Amazon scenario, we could have purchased Apple for a bargain of $0.46 a share or $46 per 100 shares. If we did only that (a $46 investment) back in 1997, we would now have 100 shares of Apple at $153.61 or $15,361. Not bad, and you would have come a long way from you initial investment twenty years ago of under $50. That gain represents a 33,293.48% gain. While not as large as Amazon, still eye-popping none the less. Especially when you consider if you decided to be a real cowboy and invest $1000 in Apple stock in 1997 you would have been able to purchase 2,173 shares of stock which would be worth $333,794.53 today.
But I hate to be the bearer of bad news. The reality is, who knew these stocks under 10 would be worth tens of thousands of times more than they were back in 1997? Maybe a handful of people, like Steve Jobs or Jeff Bezos, but let’s be honest folks, that’s where the list ends.
I don’t really want to go into too much detail, but anyone reading this post can rattle off plenty of stocks under 10 that turned into stocks under $1.
Stay Away From Stocks Under 10
These stocks under 10 can be replaced with penny stocks for the purpose of our conversation. While they are not exactly the same (penny stocks trade under $1), and while stocks under 10 trade for under $10 share, I see them as being the same. I don’t want to get into too much detail now (that will come), but to me, comparing penny stocks to stocks under 10 is like comparing apples to apple.
But while everyone gets excited about the prospects of making tens of thousands of times your money on an individual investment, I know of 3 major reasons why you and I should stay away from stocks under 10. Here we go.
They Are Under 10 For A Reason
These stocks are priced under $10 for a reason…because they deserve to be! According to Wikivest, our friend Mr. Amazon deserved to be $1.37 a share back in 1997 because they only had revenues of $147,800,000. Truth be told, I would love to own a company that had over one hundred million dollars worth of sales, but in the financial markets, that is total peanuts and completely logical to have the stock priced at $1.37. If we would like to compare that to today, Amazon brought in a cool 137.99 BILLION dollars in 2016.
Clearly, not only has the stock price come so far, but also their revenue has come such a long way.
But when Amazon was trading for $1.37 back in 1997, it was trading at that price because it deserved to. It was just a bookstore that had around one hundred million dollars in earnings. Very few people “knew” the company would turn into the worldwide leader in almost everything back in 1997.
To sum up reason number one to stay away from these companies that trade under $10:
These companies deserve to be priced this way. If a company only has one hundred million dollars in sales, it is a tiny micro-cap company that could go out of business any day they walk through the doors and sees even the slightest drop in sales. Because of this, these low-priced stocks have the risk (rightfully so) of going to zero or becoming penny stocks overnight.
Another downside of these low-priced stocks and specifically those under $5 is that a lot of funds cannot own stocks under $5. This removed a mammoth amount of liquidity and makes the risk of going to zero even larger. If a hedge fund is involved in a stock that they would like to go higher and it starts to dip, what do you think happens? That’s right, they prop it up!
But if there are stocks under 10 and specifically under $5 and those stocks tank, who is there to save it? No hedge funds or pension funds are able to be shareholders of these incredibly low priced stocks. They cannot come in and save the day. Can you or I? Absolutely not.
This just adds more risk where we do not need to have the risk. There are literally hundreds of stocks to trade and invest in that are over $10 a share that do not have the risk of going bankrupt overnight and can be supported by the largest institutions and hedge funds in times of drawdowns.
They Have Crummy Options Markets (if at all)
A simple Google search for the “top penny stocks” will lead you to a company called Ascena Retail Group. This is a stock under $10 and currently, trades for $1.73 similar to the price of Amazon back in 1997. Besides the fact that, let’s be real, nobody has ever heard of Ascena Retail Group, they also have horrific options markets.
Remember, to be able to trade a stock, we have to make sure there is ample liquidity in the stock we are looking at. We look at the options market to see if there is enough liquidity available so that we can be confident that when we put our money to work we are not going to get ripped off by the slippage of illiquid products. Here are the things we look for in a stock’s options to be able to tell if there is ample liquidity or not.
- Options volume in the thousands
- Monthly and weekly expiration cycles
- Bid/ask spreads no more than $0.05 – $0.10 wide
- Open interest in the thousands
Long story short, we are going to prove to you that these cheap stocks have horrible liquidity and that you should stay away. But just because I am just a nice guy, I will still walk you through each of these four indicators.
This is not an example of volume in the thousands as we see here we only have 763 contracts traded on Friday. Each option is worth 100 shares or $173. That gives us a total notional value traded on this options market of $131,999. What hedge funds are involved here with numbers this low? Absolutely none.
How about monthly and weekly expiration cycles. If we are to see both monthly and weekly expiration cycles, we would know that there is demand for the extra cycles.
We only see monthly expiration cycles. Any stock that trades options at all gets these out of the box.
What’s next? Open interest count? We are looking for open interest in the thousands. What do we see?
We see one strike ($3 puts) with 1000 contracts of open interest but we only see 241 open interest contracts elsewhere. Not a good sign.
And last but not least, we are looking for bid/ask spreads of less than $0.10. Looking at the image above, we do not see this being the case with most strikes having $0.15 wide markets. The sad truth here is that even if they were $0.10 in a stock like $ASNA, you would not ever be able to be filled at mid price, so you would have to give up a minimum of $5 per contract.
Stocks under 10 stink because their option markets stink. If you do not have the ability to give yourself a better chance of making money you should do one of two things:
- Walk away
- Just give me the money
You Are Going To Get Whipsawed
The lure of these stocks under 10 is real. Let’s continue with our example of $ASNA.
Many day traders get interested in stocks this cheap because of one reason and one only…they move! True day traders (those who are in and out of stock traded in matters of minutes) LOVE these kinds of stocks because they can get in and out quickly and see large percentage gains in a matter of minutes. How much can these stocks move you might ask?
Well right now, $ASNA has a one day expected move of about 5%. While that is only a. $0.08 move, it can end up being a lot of money. If a day trader were to put $10,000 to work on a trade in ASNA, they can “expect” to be up or down $500 in a day because that is the expected range for the stock on that day.
What that means for us (those who aren’t in an out in a matter of minutes) is that our positions will get whipsawed on a daily basis because there are a lot of individuals who are trading in and out of these stocks under 10 all day long.
We want to hold positions that are not going to be erratic. If we are in a stock that is acting irrational, we do not want that crazy price movement to cause us to exit our position from an irrational decision.
Wrapping Up Stocks Under 10
There you have it, folks. You’re fair warning to stay away from stocks under 10.
Yes, I know.
Amazon and Apple and blah blah blah.
However, for everyone one of those, there are handfuls of stocks then went from just under $10 to under $1 and then to bankrupt.
Here are the three reasons to stay away from these cheaply priced stocks:
They Are Under 10 For A Reason
They Have Crummy Options Markets (if at all)
- You Are Going To Get Whipsawed
It’s not hard folks. Just stay away!