Is there a single investor in the world who is not thinking about buying stocks? Truth is, probably yes, however, there are not so many of them. Especially if you think about buying a stock, for example, a couple of dollars, and witness it grow a hundred times bigger, giving you a chance for a quick gain. Isn’t it a dream of any investor? This is exactly the reason people invest in penny stocks.
Investing in a penny stock requires more than a modicum of caution and care. These stocks carry the potential for outstanding returns and as such, come with a high level of risk.
Dabbling in the world of these stocks demands that the investor understand what they are getting themselves into if there is to be any chance for success. The first step is to consider what a penny stock is.
What Are Penny Stocks?
Once considered to be any share trading for under one dollar, the Securities and Exchange Commission (SEC) defines them as stocks that trade for less than five dollars. The SEC is a federal agency that operates independently and protects investors by maintaining orderly and fair functioning of the securities markets.
Infrequently traded and often associated with smaller companies, these smaller stocks are rarely traded on large exchanges like the New York Stock Exchange (NYSE). Most are traded via privately owned groups, through the Pink Sheets, or on the electronic Over the Counter Bulletin Board (OTCBB).
To better understand the nature of these stocks, it is important to know they are issued by the companies whose future can hardly be predicted and whose income at the moment of selling their stocks is unstable. Therefore, they can present both a great opportunity and a huge risk, at the same time. The fact that these companies are not seen as having a big worth, doesn’t mean that it cannot grow in the future. But, let’s discuss more about the risk and reward in the continuation of the article.
What Are the Risks?
A plethora of risks exist when trading these stocks. They are generally considered highly speculative, meaning that investors could lose all or a large chunk of their investment. Knowing what the risks are before you invest is essential.
The principal risk of lower-priced stocks is their lack of readily available and reliable information. For the most part, stocks traded through avenues other than the NYSE and other large exchanges are for less established companies. These companies are not required to provide the same amount or type of information that stocks listed through the large exchanges are.
Lack of information on available money stocks makes it difficult to make an investment decision, based on common sense and facts. Investors are very likely to meet a few people who declare themselves as experts in this matter and ask for a payment in exchange for knowledge or stock information. One could think that these services are a good way that will help in making a decision, but it’s mostly a scam. Investors need to be aware and not fall into such traps.
Beyond the lack of an adequate track record on which to base one’s evaluation, these stocks are also susceptible to scams. A popular scheme for a penny stock is known as the pump-and-dump. In this swindle, investors buy up a stock to pump up the valuation and then dump it when it appreciates. This often goes unnoticed due to the ambiguity of penny stock companies which do not get the same sort of attention big corporations do. Unknowing investors who buy these stocks at the high end are often left taking a loss after the big dump.
These lower-priced stocks are also known to have low liquidity. It may be difficult to unload these stocks when the time to do so presents itself and that can be costly.
Investors also need to be aware of the possibility of losing all of what they have invested. Giving the fact that that money stocks are highly unpredictable, as we previously mentioned, it is difficult to assume in which direction the stocks will move.
Another risk is that these socks are not so often traded. Being aware that certain difficulties might occur if the investor decides to re-sell the stocks, after purchase. Difficulties in getting quotations for the stocks are also likely to occur.
What Are the Potential Rewards?
As with any big risk, the rewards associated with successfully trading a penny stock can be immense. These unknown companies have the same potential to explode in their market as any larger version does. As the experts at Money Market said about penny stocks, “Investors are always looking for the next biotechnology breakout.” That extends beyond biotech into other markets too. Many excellent companies are traded for pennies and eventually grow to dominate their industry. Getting in on the ground floor can be very lucrative. You can find more information on moneymorning.com.
Although highly volatile, penny stocks or small stocks can bring pretty appropriate rewards. The best thing about volatility is the excitement because the stocks have the potential to show great growth in a short period, therefore are one of the popular investment decisions. Also, a massive profit can emerge from very little capital invested. As their name says, they start small, but there’s always growth potential.
There are many examples of the companies that used to be penny stocks and have developed over time, becoming the leaders in their area. Companies such as Xerox. So, not only the risk is associated with these stocks. Even though as an investor you may wait for a couple of years for the investment to grow, there’s also a possibility for this to happen in a year, or even in a couple of days. Volatility can also be seen as an advantage.
In any case, investing in these stocks should not be entered into without understanding what the pros and cons are. These little investments can be a lot more complex than they seem.