What is a penny stock? And what is the problem with them?
What is a penny stock? Penny stocks are small-cap stocks that trade at a relatively low price. Penny stocks trade outside of the leading market exchanges.
In the Indian stock market, for example, the costs of the Penny stocks can be as low as under Rs 10. Naturally, small-cap stocks are prone to speculation and are considered extremely risky.
• It lacks liquidity
Two issues arise when stocks require cash. First, there is a chance that the stock may not be able to be sold.
Low liquidity means a scarcity of buyers, which may result in you having to lower your price to attract a buyer. Second: low liquidity results in the increase in possible manipulation of stock prices.
• It lacks history
Most companies that are considered small-cap stocks are either moving towards bankruptcy or they are newly formed.
Hence they would have poor or no track records at all, and this makes it hard to distinguish the potential of a stock.
• Its information is not readily available to the public.
It is essential for the success of any investment strategy to have enough relevant information for informed decisions to be made.
However, it is complicated to find information for small-cap stocks. Furthermore, the information that is there is not from reliable sources.
• It does not have minimum standards.
Stocks that are on pink-sheets and the OTCBB are not required to fulfill minimum standard conditions to stay on the exchange.
Let us answer the question, “what is a penny stock?” in a more precise manner.
In the western market, stocks that trade under one dollar known as penny stocks.
However, according to the SEC, this includes stocks under $5.
Although Penny stocks are high risk, they have great potential of bringing in a substantial return on investment from a minimal investment.
For example, let’s assume you have 60 000 shares of a penny stock for $1. A $1 increase can result in a $60 000 gain for you in just one day.
Such would not happen in the case of large stock, because to buy such a massive volume of shares, you would need a lot more capital.
While we can clearly choose to dwell on the opportunities and potential that the Penny stock provides.
We must consider that it has quite a few downsides as well.
Some of which include price manipulation, regulatory reviews, and unforeseen delisting.
By purchasing thousands of shares, one can move the stock and leave no sign for the average investor to differentiate between genuine and manipulated spike in price.
Another critical thing to remember about penny stocks is that they are more vulnerable to scams. The reason is that, in most cases, the penny stock stays regulated by a stock exchange at a national level.
Penny stocks put in their category called the trade to trade basket because of the risks which come with it.
In the business to trade basket, intraday share trading stays not allowed.
All transactions must be done on a gross basis, meaning that you have to deliver shares sold on the same day and take delivery if you bought shares.
Penny stocks, a high temptation for investors
Do you know what to expect when you trade on Penny stocks?
We didn't find an official definition for "penny stock." But it's generally considered as trading on small-cap stocks that can be bought from few cents (pennies) to less than a few dollars.
And these products can remain traded on the stock exchanges, but also outside of it. At this price, many see the opportunity to fill their portfolio of shares from a small capital.
Penny stocks and easy profits generated
However, we can hear from ordinary investors that anyway, the price is more likely to take off one day than to drop even more.
They are not entirely wrong, but they are not quite right either. There are still some risks you need to know before you jump on these cheap stocks.
Penny stocks: the risks mentioned above
As we said, penny stocks continue considered as such when they belong to small-cap companies.
Some big companies also sell their stock at a low price, but not everyone agrees that it's also penny stock.
Why? Because their low price is the only common feature with "real" penny stocks that have other peculiarities, including.
- Low liquidity: in general, small caps are less attractive to investors than large companies.
If the growth potential of such a company stands higher, the risk remains also increased.
Some will try to launch, but the exchanges are nevertheless few, and the listing suffers from a lack of liquidity. This can make your orders never run at the level you initially set.
- A lot of volatility: this is one of the direct consequences of the lack of liquidity. The slightest movement is amplified and has an immediate impact on the price. And you can lose in a second what you needed months to gain.
- The price of these shares lives more easily manipulated, which added a consequence of the lack of liquidity: the cost of these shares means more easily shaped. If each movement is amplified, it becomes effortless for someone unfair to try to manipulate the course of the stock in one way or the other.
This leaves little chance of survival for the average investor.
- You have little financial data to do a thorough analysis. Most of the companies to which these penny stocks belong are still young. And you'll have a hard time finding enough financial data that allows you to judge the strength of one company over another objectively.
However, penny stock, always attractive!
If you are well aware of the risks and do not throw yourself headlong into buying these titles just for their low price, you do not need to run away from them.
It's indeed profitable to find small caps in which to invest. And the principle is the same to choose the penny stocks that you can potentially buy or the ones you need to avoid.
There is even a way to figure it out easily using a Prorealtime screener. The screeners are intelligent trading programs.
They can make a selection that allows you to find the most exciting penny stocks. Then you just have to look at the charts and judge their potential.
Penny stock, risky for the newbie?
The shares move quoted in cents and sell for less than $ 1. But if they imply cheap, the risk associated with it holds essential.
Penny stocks remain mainly issued by start-up companies, which act, therefore, the riskiest for investors.
And if again of a few cents per share can quickly be synonymous with hallucinating performance, the same principle is true for losses!
Also, this kind of product acts not followed by all financial analysts. So you have very little chance to get full information and able to know perfectly what you are investing in.
It's a bit like playing the lottery, take your chance so. But be aware! If you still want to get involved in penny stocks, make sure you pick the fresh ones.
Even though penny stocks surely have tremendous potential, you must have realistic expectations before getting involved.
Generally, it takes months, maybe years, to see results and gains in the stock market. If you buy penny stocks expecting to turn $100 into $60 000 in a week, you may be deeply disappointed.