What are penny stocks?
Penny stocks are those that are generally traded for less than $5, some even at a fraction of a cent – hence the name. Some definitions vary the cut off point at $3, some at $2 and some at $1. Penny stocks are high risk in the trading world, which is why some investors are afraid of them. On the other hand, penny stocks are also unpredictable and highly rewarding, able to potentially make their courageous investors a lot of money.
Why penny stocks are so appealing
Penny stocks have created more overnight millionaires than any other type of stocks or other investment means. Even small investments of penny stocks can become decent fortunes, which is why most investors choose this safer path.
Risks of penny stocks
Because penny stocks are so volatile, there are larger price movements in shorter periods of time. At most, you can lose 100 percent of your investment, just like gambling. But also similar to gambling, if you invest large amounts of money in penny stocks then that is a large amount to lose. I suggest only investing what you believe you can afford to lose.
Some of the reasons why penny stocks are so risky are as follows:
- Lack of information – The best strategy for making intelligent decisions when investing is to gather enough information to do so. With penny stocks, finding important information is much harder because many times it is not available to the public. Companies that generally fall into the penny stocks range are usually listed on the “pink sheets” (over-the-counter stocks) and are not held to the same standards as regular stocks; therefore they are less analyzed. Also, most of the information concerning penny stocks that is available is usually not from a credible source but rather based on hearsay or guessing.
- No Minimum Standards – As stated above, companies that are considered penny stocks are not held to the same standards as more expensive stocks and do not have to file timely documents or other basic information that is helpful to investors. The minimum standards of the bigger stock markets like the New York Stock Exchange are viewed as a safety cushion and stepping stone for many investors.
- No History – Many of the companies with penny stocks are newly formed or approaching bankruptcy, meaning they have a poor track record or none at all. This lack of history makes it more difficult to choose the right stock.
- Liquidity – Liquidity is the ability of assets or stocks to covert to cash quickly. Penny stocks are less likely to have a high level of liquidity, making it more difficult to try and sell the stock. Sometimes you have to lower your price in order to find a buyer and other times you cannot sell penny stocks at all. Another trick that is often played with penny stocks is known as “pump and dump” because an investor buys a lot of one stock to get it hyped up and others interested, then sells it all quickly.
By Monica Drusch