Let’s face it, we have all come across stories about people going from rags to riches in the investment world. More often than not, these riches are usually because of transactions involving penny stocks. But, what exactly are penny stocks? These are shares that are floated by small public companies that are unable to meet the listing requirements of most stock exchanges and are usually priced under $5. Penny stocks may also include securities of a private company, which may not have a trading market. These highly speculative and low priced securities are not listed on any stock exchange, but can be traded on the securities exchanges, which include foreign securities exchanges.
Two electronic exchange where penny stocks are usually quoted include Pink Sheets and Over-The-Counter Bulletin Board (OTCBB). When compared to blue-chip stocks, penny stocks can actually turn out to be more profitable. There are a number of pros and cons that investors can enjoy when they decide to invest in penny stocks. Let’s take a look at some notable ones:
Pros of Investing in Penny Stocks
The possibility of making huge returns
Similar to gambling in casinos, investing in penny stocks means that there is always a possibility that you might hit it big. Just like it is possible for a poker player to gain a significant benefit over the rest of the table at the casino, an investor who has done proper research in penny stocks can tilt the odds in their favor.
Increased volatility means returns are quicker
Typically, when you make an investment in a growth stock listed on the popular stock exchanges, you expect it to give you returns in one, two or even five years, if you are patient enough. In contrast, penny stocks have the capability of experiencing exponential growth in just a matter of days, and sometimes even in a matter of hours.
Not all companies with penny stocks are managed poorly
A lot of people who are against the concept of penny stocks believe that mostly all of the companies that trade on the pinks have poor financial evaluations and are managed poorly. However, this is not the truth at all. There are a horde of solid companies that are simply not big enough to be able to trade on the big stock exchanges so they opt for penny stocks trading. A good penny stock trader will be able to find such diamonds in the rough and invest in them for greater returns in the future.
Penny stocks can be bought for a very low price
There are people who believe that just because they are called ‘penny stocks’ they are traded for pennies, but this is not the truth. Penny stocks can include any shares that have a price tag of under $5, but the large majority does tend to trade in pennies. This means that investors can buy a large amount of penny stocks at a low price and this can be immensely useful for those who don’t have a very big budget.
Cons of Investing in Penny Stocks
The risk of an empty bank account
The truth is that penny stocks can be very risky. As a matter of fact, they are considered too risky or most people’s risk tolerance levels. Even the strongest people can be doubtful because penny stocks are extremely volatile and not everyone is capable of handling that. When you decide to trade penny stocks, you have to take the highs with the lows and learn when to cut your losses. It is simply not possible to win every single trade. As a matter of fact, there is a good chance you will lose a large number of trades when trading penny stocks and it is a good idea to limit them to the point where you can cover them easily.
Finding accurate information about companies is difficult
One of the rules that companies have to meet when they list on the stock exchange is to submit their financial earnings and reports. Unfortunately, this requirement is not applicable on companies that sell their penny stocks. Therefore, those trading in penny stocks are either relying solely on technical indicators or trading fundamentally blind. Some are simply making a guess. It requires a pretty big shovel to dig for financial documents on companies trading on the pink sheet and even then you may not find anything.
Penny stock scams are rampant
Scams involving penny stocks are quite rampant, whether they are the short and distort or the pump and dump. As penny stocks are thinly traded, even a substantially little action can have a deep impact on them. Thus, you need to be careful when you are signing up for newsletters of penny stocks and only opt for the most reputable ones. It is possible that some newsletters are trying to trap readers into a scam by purchasing a large number of penny stocks. They are promoted in such a way that can have an impact on their movement and then sell them off for a huge profit whereas you end up empty handed.
Commission could be hefty
When you sign up for a broker for trading stocks available on indexes such as the NYSE, you are required to pay a streamlined commission. In comparison, the brokerage fee charged for trading penny stocks can be substantially higher. Therefore, this is something that traders should be aware of when they are signing up with a brokerage as it could turn out to be very costly. Look for brokers who charge a reasonable commission for trading penny stocks and you are good to go.
These are some of the pros and cons that you will experience if you decide to invest in penny stocks. If you believe that you have a strong risk tolerance and can control your emotions, there is no harm in investing in penny stocks. They tend to be volatile and have a highly speculative nature, but can give investors huge returns.