Penny Stocks

What Are Penny Stocks?

Most financial analysts and stock brokers define penny stocks as stocks that trade for less than $1.00 per share. However, there are many people in the financial industry that consider any stock trading for less than $5.00 per share to be a penny stock. Most penny stocks do not meet the listing requirements of the major exchanges. The majority of penny stocks are, instead, listed on either the Over-the-Counter Bulletin Board (OTCBB) or the Pink Sheets. Some, however, are listed on the exchanges.

Advantages of Penny Stocks

There are several reasons that penny stock trading is popular. First, the upside potential is enormous. A stock that goes from trading for a few cents to trading for just a few dollars will give an investor a tremendous return. Some companies whose stocks traded for pennies are now major businesses. Second, people trading penny stocks can potentially buy a large number of shares for a relatively small investment. For people who do not have a lot of money to invest, trading penny stocks is a way for them to gain experience in the investment market.

Risks of Penny Stocks

Trading penny stocks can be risky because many of these companies are not on a sound financial footing, and they often lack the management and marketing talent to develop into stable businesses with growth potential. So, the possibility of investors losing their money is much greater with penny stock trading than it is trading securities listed on the major exchanges. Many, but not all, of these stocks are also thinly traded, so it can sometimes be difficult to liquidate a position. Furthermore, penny stocks are often targets for scams and cons. They are a favorite among con men who work the “pump and dump” scam. These people buy a large position in a penny stock and then begin to “pump” the company through online postings, emails, telephone calls, falsified press releases, fake financial newsletters, and any other means that they can think of. When the stock price rises, they “dump” their position by selling out at an inflated price. Since there was no real reason for the stock price to rise, it begins to fall when the scam artists stop pumping it. Consequently, investors who bought at higher prices suffer losses.

Penny Stock Trading

To buy and sell penny stocks, you need to open a brokerage account. This is easy to do and can be done online at many brokerage firms. Once, you've opened an account, you need to put some money into it. Penny stocks are not the type of securities that you generally buy if you're seeking safe investments. Most of these stocks are speculative in nature, so do not invest money in penny stocks that you cannot afford to lose or that you may need quickly. Next, you should thoroughly research each stock before investing in it. Try to find neutral, fact-based sources of information. This can be difficult to do because information on many penny stocks is often scarce because no stock analysts and few news services follow these stocks. If you cannot find enough information on a company, then find another stock. Penny stocks listed in the Pinks Sheets and the OTCBB, especially those trading for less than a penny a share and those with five-letter symbols, are generally considered the riskiest penny stocks of all, while those that trade on the AMEX, regional exchanges, the NASDAQ SmallCap, and other exchanges with listing requirements are usually considered less risky. Do not act on stock tips that you receive via email, telephone, or free newsletter. These are tools of the scam artists who “pump” stocks. When you do place an order to buy, strongly consider placing a limit order instead of a market order because a market order may result in your paying a much greater price for your order than you anticipate. Limit orders allow you to set a maximum price per share that you will pay for a stock.