Penny stocks are one of the best ways to make a lot of money in the stock market. But, it’s also one of the most dangerous ways to invest. There’s a lot of risk involved. Here’s how professional investors manage that risk, and make it profitable.
What Are Penny Stocks?
Low-priced, small-cap, stocks are also known as penny stocks. Contrary to the name, many penny stocks are not really priced at one cent per share. The SEC considers penny stocks anything under $5 per share, making them a “cheap stock” for most investors. While there are stocks under $5 trading on large exchanges like the NYSE and NASDAQ, many investors don’t think of them as penny stocks.
Most individual investors look at penny stocks as very risky investments because of the price and the fact that many of these stocks have thin trading volume. Meaning, the stocks don’t have many buyers and sellers. In these kinds of markets, stock manipulation is easier than for larger stocks where there is a wide diversity of stockholders.
Most individual investors are also intrigued by the idea of penny stocks, because they can make fantastic moves in a short period of time. According to http://moneymorning.com/tag/penny-stocks-today/, there are penny stocks every day making moves of several hundred percent.
But, how do you find these stocks?
Just because you don’t hear about them every day in the popular or mainstream media doesn’t mean that they’re not worthy of your consideration. At the same time, penny stocks have gotten a bad reputation for being a “game” filled with scams and corruption.
How To Find Them
Like any stock, you can buy them online or through your broker. Even if it’s not listed in a major exchange, you can usually find them through mainstream brokers and purchase shares directly. While cheap stocks on exchanges like the NYSE and NASDAQ aren’t considered “penny stocks,” they sometimes act like it. These exchanges have strict listing requirements, so they don’t allow for as much of an upside as other stocks you might find off the exchange.
This is both a curse and a blessing. It can limit your upside potential, but it can also protect you from being taken.
Over-the-counter Bulletin Board, or OTCBB is a quotation service. Unlike Pink Sheets, which basically just publishes quotes, OTCBB maintains listing requirements for stocks. They’re not at stringent as a major exchange, but they do have them.
Pink Sheets is a basic system for quotation information on stocks registered with it. They aren’t registered with the Securities and Exchange Commission (SEC) however, and because of that the SEC won’t enforce any listing requirements.
Because penny stocks are highly volatile, they offer amazing upside potential. They also offer amazing risk to the investor. You could lose a lot of money by investing in them. This is tempered by the potential, however, and is one reason why some investors love investing in them.
Companies can often move by thousands of percentage points within weeks, making it one of the most rewarding investment experiences ever. Of course, the trick is finding the right stock.
Risking It All?
Even legitimate penny stocks can be risky. Two reasons for this are that penny stocks have inherently low liquidity and there are poor reporting standards. Sometimes, you just don’t know what you’re getting yourself into until it’s too late.
Liquidity problems can become a major problem when you want to cash out of your stock quickly, but there are either no buyers or no money in the market to make the transaction. According to the Securities and Exchange Commission, penny stocks can trade infrequently, meaning it might be difficult or impossible to sell your shares after you buy them. Because it’s hard to find quotes for certain stocks, you might find it difficult or impossible to price them accurately.
Profiting From Penny Stocks
Even with the risks, it might be worth it. Here’s why: When a company is legitimate, and its stock is a penny stock, you can capture amazing upside potential if and when that company ends up announcing major news about one of its products or services — as long as it’s positive news.
You still need to look over the company’s financials, and its fundamentals to access whether it’s a good investment. As long as the company is sound, and the fundamentals are there, it may be worth buying shares if you understand the company, the risks, and are willing to allocate a portion of your capital to the investment.
While nothing is guaranteed, you also can’t win what you don’t put in the market.
Chloe Middleton is an investment banker by day, and a geeky gamer by night! Personally she enjoys keeping up to date with all aspects of investing, including the latest technology trends to help wannabe investors. She writes on these topics for a range of blogs.