Penny Stocks – Are They For You?

 

The growth in online stock trading in recent years has been partially due to a growth in the number of people of who trade for “penny stocks.”

The SEC defines anything that sells for $5 a share or under as a penny stock. These are low-priced, speculative security of small companies. There is usually a market cap under $500M. They are are outside of the major stock exchanges (NYSE, NASDAQ or AMEX). Other terms for penny stocks are mircrocap stocks, small caps, and nano caps.

 

There is a potential for gain, however, there is also a risk involved in when investing in a penny stock (SoS).

The intriuge of these cheap stocks comes from their low prices and great growth potential. The flip side is that severe losses can occur. New investors should be informed of the risks associated with these stocks. This includes a lack of financial reporting, fraud, and limited liquidity. Limited liquidity means it will not trade as many shares on a daily basis like a larger company would.

Unlike the NASDAQ and the NYSE, there are minimal requirements for a penny stock to remain on the OTCBB (Over the Counter Bulletin Board). Some companies that fail to meet the minimum standards on one of the broader exchanges and often relist on the OTCBB or Pink Sheets. Stocks traded on the Pink Sheets (.PK suffix) have little or no regulation or listing requirements as compared to the major markets. This makes them riskier.

With online stock trading,a penny stock is also more vunerable to fraud than other larger stocks. Frequently some claiming to be unbiased people who have throughly researched the stock will say a particular stock is the hottest around and should be purchased immediately. This drives the price of the stock up and those who created the scam sell theirs while the price is high. The insiders benefit and those on the outside lose.

A mistake investors often make in regards to choosing a penny stock is assumming that the giant companies of today were once penny stocks in the their early days (Fool). They make this mistake by looking at the adjusted stock price. This dollar amount takes into account all of the company’s stock splits, however. These splits happen when a company believes the price of their stock is more than the an individual investor would pay. When the split occurs, the price of the stock decreases but the number of shares increases proportionately. Without taking this adjusted price into consideration, viewing the stock price of large companies can be decieving.

Trading a stock with low face value is not always bad, however. In many cases, the stocks are in new companies. As a result, you could potentially be investing in a company that will explode in growth. This could be potentially very profitable for the trader. In addition, some penny stock may be quality stocks who are working hard to make their way up to the more reputable Nasdaq and NYSE.

 

Although there is a considerable amount of risk involved in penny stocks in online stock trading, there are also some benefits. With a through understanding of these unique stocks, there is a potential for moderate profits.

 

References:

Missouri Secretary of State

Fool