Should I Buy Penny Stocks?
In the US stock market, stocks that are priced under $5 are known as penny stocks. They are typically traded outside major stock exchanges like the NYSE or NASDAQ. Trading in penny stocks usually takes through pink sheets or over the counter bulletin board (OTCBB). Since these stocks are priced so low and they have a small market capitalization, they are prone to extreme fluctuations. This means that when you buy penny stocks, you are exposing your investment to a bigger risk than when you buy blue chip stocks.
Given the risk involved, you need to be very good at trading if you want to make money from penny stocks. You also need to be able to take quick decisions, as the window of opportunity in these stocks can close very quickly. Sometimes these stocks trade so low that they risk losing their listing on the stock exchange. Quite often, but by no means always, the company which is seeing its shares traded at such a low price will be in a bad shape.
Pros and cons of investing in penny stocks
If you are a seasoned investor and know how to operate in the stock market, you can buy penny stocks as part of a broader investment portfolio. The pricing at sub $5 levels can be a major temptation, but you should not forget that the price of the stock might be low because the company is not doing well.
Some investors use penny stocks to test their trading strategies. You can trade on these stocks without losing a huge sum of money, thanks to the low prices.
The downside of investing in penny stocks is the risk involved. If you are researching options in penny stocks, you would’ve probably noticed a dearth of information from credible sources. Moreover, listings on pink sheets don’t necessarily mean that the stocks are closely regulated by the Securities and Exchange Commission.
Another disadvantage is that most penny stocks have a low liquidity. This means that you may have a hard time finding a buyer when you’re looking to sell the stocks. In fact, sometimes the bid-offer spread for these stocks can exceed 10%. Some investors inflate the price by making misleading claims and sell their low priced stocks at a higher rate. In trading parlance, this micro cap fraud is known as “pump and dump”.
What’s the safest way to invest in penny stocks?
Not all stocks listed on pink sheets and OTCBB are bad investments. You can buy penny stocks provided you have the understanding and skill required to trade them. One the other hand, you cannot assume that all penny stocks are undervalued.
Before you buy penny stocks, you should always look for more information on the company’s earnings per share, where it stands in comparison with its competitors, and what are its future prospects. Go for solid companies whose stocks are priced low because of their size and not due to financial problems.
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