Cheap vs Expensive Stock Debate
Say you had $1,000 to invest, you are given two options :
Option A : Invest $1,000 if the trade is successful you will have $1,480 after, if it fails only $520
Option B : Invest $1,000 if the trade is successful you will have $1,470 after, if it fails only $950
Which would you pick?
If you picked option B, you are correct and you purchased the more expensive stock. If you picked option A, keep reading!!
We are constantly being told that new investors cannot afford to buy expensive stocks because they can only afford to buy a few shares.
We will break down a case of a cheap stock vs an expensive stock and will debunk how it's a load of crap!
The two stocks in this example will be ARGS (cheap stock) ARG (expensive stock)
Both formed nice bull flags, the main difference is that with the ARGS (cheap stock) you had $3 risk for $3 of gain. While ARG (expensive stock) you had $3 risk with a $50 gain.
$1000 Investment in both
ARGS (cheap stock) $6 stock ARG (expensive stock) $100 stock
ARGS 160 shares bought ARG 10 shares bought
ARGS Entry $6 ARG Entry $98
Risk If Trade Fails
ARGS Stop $3 ARG Stop $93
ARGS Risk $3 per share ARG Risk $5 per share
Dollar Risk $480 Dollar Risk $50
(160 shares x $3 ) (10 shares x $5)
Profit If Successful
Stocks at $9 Stocks at $140
$3 gain per share $47 gain per share
$3 gain X 160 shares $47 gain x 10 shares
$480 gain $470 gain
$3 risk $3 gain $5 risk $47 gain
“To make money successfully long term, you need to take trades where the risk reward is 5:1 or greater.” Ray Dalio (regarded as one of the most successful hedge fund managers)
This is why in most cases, trading cheap stocks the risk is far too great, there will always be exception to the rule. Regarding trading long term, we need to manage our risk to stay in the game. If the cheap stock fails and you loose 50% of your investment account, you will need a 200% gain just to break even. With the expensive stock and a proper stop, you can risk 5% and loose, you will only need a 6% to gain back to break even.
Which did you originally pick option A or B?