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My investing horror story: penny stocks

The Motley Fool logo The Motley Fool 4/13/2018 Reuben Gregg Brewer
A man with his head on a table and a chart in the background that first goes up and then sharply down © Getty Images A man with his head on a table and a chart in the background that first goes up and then sharply down

Penny stocks turned into a lingering black spot on my brokerage statement. Luckily, I learned this investing lesson while I was still young

When I started investing over 25 years ago, I read any stock book I could get my hands on. I wish the first book about investing I had found was Benjamin Graham's classic The Intelligent Investor. Unfortunately, it wasn't. I read Wade Cook's Wall Street Money Machine. With little money in my brokerage account, I latched onto his "rolling stock" concept and applied it to penny stocks. It turned into an investing horror story that I was reminded of every time I looked at my brokerage statement.

When you first start investing, you don't really understand what's going on. That's doubly true when you are in your teens and still have yet to figure out how the world at large works. I was looking for the get rich quick trick that would make me money -- fast!

I now know that there is no trick, at least not a legal one. You have to put in your time doing research, and then put in the time to let your investments grow. Every so often you'll get lucky and you will time an investment just right, which is exciting but not the norm. However, I didn't know these simple truths when I started out.

So when I read Wade Cook's book, suggesting that getting rich was as easy as looking at a few stock charts, well, I was in. The plan sounds simple enough: find stocks that have been trading in a price range, and then trade that range. So you buy the stock when it's at the low end of the range and sell when it gets to the high end. He called this rolling stocks. It gets even better, however, because you can put this little plan on automatic by using good till canceled orders, which tell your broker to buy or sell if a stock hits a certain price in the future.

Although Cook said his rolling stock concept could be applied to larger companies with higher stock prices, it was clearly more effective with tiny companies that traded in the $1 range. Small price changes translate into big percentage moves with penny stocks. And since I was just starting out as an investor, I didn't have much money, which meant I could buy more shares of a penny stock than one trading for $40 a share.

And the worst thing that could happen did.

Why did this happen?

When I look back on this episode now, I joke that the worst thing was that I made money. I don't remember the companies, and I never really knew anything about them, but Wade Cook's rolling stock idea made me money. Which I then promptly used to increase my rolling stock penny investment bets. This went on for probably a year, and life was great. We still weren't talking about huge amounts of cash, of course, but I was young, and seeing trades ring up a $100 profit in a month or two was incredibly exciting. In some cases the annualized gains I was making were more than 100%. This was magic!

Then it suddenly stopped working... I had gone all in on a few trades, and the bottom end of the range didn't hold. When I finally noticed what had happened it was too late. I was left to watch the stocks slip lower and lower, hoping the penny stocks I owned would jump back to the old range. That didn't happen. The penny stocks ended up going belly up.

The problem with penny stocks is that they are often tiny and financially weak. But I hadn't done any research on the stocks I owned other than look at their charts and get a cursory understanding of what they did. I certainly didn't take the time to look at their financial statements, all that mattered was the chart. And those broken tickers sat on my brokerage statement for years as a reminder of my investment mistake.

A lesson learned

I'm actually lucky: I made this investment mistake with penny stocks while I was still young and had little money to invest. So the real damage was to my ego, not my lifetime savings. But I've always tried to remember this experience because it contains some important lessons. One, there's no such thing as getting rich quick in investing. Two, you need to know what you own and have a good reason for owning it. And three, you need to watch what you own.

My investment approach is far more complex today and centered around dividend payers like U.S. steel giant Nucor and integrated energy goliath ExxonMobil. But every so often I need to stop and think back to my younger self to remind myself about some basics. In the end, trading rolling penny stocks has been valuable to me -- not because it made me money, but because it was a life lesson on what not to do as an investor.

Related video: Meet the millionaire who built a penny stock fortune (provided by Bloomberg)

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Reuben Gregg Brewer owns shares of ExxonMobil and Nucor. The Motley Fool recommends Nucor. The Motley Fool has a disclosure policy.

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