There’s an old saying that says that “you get what you pay for”. Probably you’ve never stopped to think about this, but today is the day. What would you say to someone who offers you the latest smartphone in exchange for just $150? You don’t need to be a genius to figure out that it may have some functionality issues that will appear sooner or later. Well, the same principle could apply to the world of investing in regard to penny stocks.
What are penny stocks?
Penny stocks are stocks that can be traded for a price lower than $5. In some cases, their price could go even lower than $1. Generally speaking, penny stocks come from companies going through their initial growth stage.
Wait… ONE dollar? For a stock? You’re kidding, right?
This may sound too good to be true, but hold on. Relax and take a couple of deep breaths.
You might be tempted to go all in such cheap stocks, but as in every kind of investment, you should first do your own research and find out what’s behind that price.
Pros of penny stocks
There’s no need to say the main advantage of penny stocks is their market price. They are cheap and affordable to anyone who’s looking to get into the exciting world of investments. You don’t need millions in cash, so you could buy a lot more shares in comparison to other investing methods.
Besides their low price, penny stocks grow at a much faster rate, which is why you can make some gains in a short period of time.
On the other hand, depending on how much you invested, the risk of losing your money could be lower as well, due to the fact that initial investment amounts are lower.
Penny stocks may seem like a clever idea. Their benefits can be very attractive to some; however, it is not all a bed of roses. Before investing your hard-earned money in penny stocks, make sure to look at the other side of the coin as well.
Why not invest in penny stocks?
Penny stocks are riskier than other investment instruments. These are some of the main reasons for this.
Scams and little regulation
Penny stocks are usually traded in Over-the-Counter markets. These markets have fewer regulations, which is why they tend to be less transparent with their operations. Most companies that are part of OTC markets are not able (or willing) to provide proper financial documentation. Some of them are even in bankruptcy.
As if this was not enough, believe it or not, the penny stocks market is filled with scams. Because of its smaller size, it is the perfect environment for fraud and transaction manipulation.
For this reason, just a handful of brokers offer services with these stocks. Dive a little deeper to discover all the different types of scams related to penny stocks.
Little public information
As we mentioned earlier, penny stocks represent small companies, which in most cases are not completely established. Investing in them may not be a good idea because it is not quite necessary for them to follow a set of rules for their financial statements.
There’s not much information about their performance and it is likely that the available information out there comes from a not-trustworthy source.
From that point of view, it may not be wise to trust your money to an unregulated and poorly established company. You could lose all your investment in case the company goes through rough times.
Penny stocks are totally unpredictable. Their price may vary completely overnight. This may have a bright side, obviously, in case the market works in your favor. However, keep in mind that all your investments may take a nosedive in the same way. Always remember that greater volatility means greater risk.
Investors who trade penny stocks usually implement stop-loss orders. These help their stocks to be instantly placed back on sale at the very moment in which their price hits a low determined value.
Lack of buyers
Let’s imagine you buy a couple of hundred of dollars in penny stocks and their price goes up. That would make you feel like an old wolf of Wall Street ready to make it rain just like in those internet memes.
Sounds amazing, nevertheless, chances are you will not be able to sell your stocks immediately to receive those profits. Penny stocks are relatively illiquid, which means that you won’t find a lot of available buyers. It may take you a day or two to find someone who wants to buy your stocks, and they may have already lost their value by the time you meet up with someone interested.
To wrap it up…
Investing in penny stocks can be very risky. While you’re deciding whether or not to buy some, ask yourself: Do I want to invest in a company that is not well-regulated? Do I want to be a part of a market with few regulations? Do I want to risk my money in illiquid assets?
Make sure to keep doing your own research before making any decisions about your financial future. You can get a little more guidance by checking out the rest of our articles about investing strategies. You’ll surely find one that fits you better.