What are penny stocks? In the US financial markets, penny stocks are referred to as stocks which aren’t listed and traded in any of the major Exchanges. Because of this, penny stocks are also known as over-the-counter stocks. According to the SEC, “The term ‘penny stock’ generally refers to low-priced (below $5), speculative securities of very small companies. “
Most seasoned investors and brokers don’t want to have anything to do with penny stocks. After all, these stocks are considered extremely high risk investments. A typical penny stock company has a market-capitalization of less than $500 million and is considered less liquid compared to mid-cap and large-cap stocks since it has less shareholders and is therefore traded less frequently. Less shares also mean a high volatility in a stock’s price. Its price can soar up in a blink of an eye, as well as come crashing down with lightning speed.
A major concern regarding penny stocks and its lack of liquidity is that trading can be extremely risky. First of all, if you buy shares in a particular penny stock and there aren’t as many interested parties, you might end up holding on to those shares for a long period of time. The worst case scenario is for you to lose a huge amount of money buying stocks nobody wants. And that’s just the part regarding the case of “the honest mistake”.
Lack of liquidity and high volatility makes penny stocks susceptible to manipulation, either by management or outside parties. Penny stock frauds are not uncommon these days, especially with the easy accessibility that technology allows us to enjoy. Examples are telephone calls from brokers claiming to have “insider information” and “hot tips”, as well as unsolicited email (spam) coming from strangers who claim to be “experts who know a hot deal” that they want to share with you. Common sense dictates that one should not trust strangers. But with all the successful scams going around, it seems like common sense isn’t so common after all.
So how do people manipulate penny stocks and leave the investor reeling horror from losing his money? There are many ways, actually, but the most commonly used scam is the “pump and dump”. In this scenario, the evildoers will buy a lot of shares in a particular stock while at the same time hyping up the stock in such a way that it will seem like the rising stock is indeed doing well (pumping). The victim, having been fooled and most likely without the necessary tools for verification, will unwittingly buy the shares of stock from the perpetrators who will then proceed to dump the worthless shares and reap a lot of cash. There are many variations to this scam and they seem to work, especially when the victim happens to be too trusting. These people are generally the old, naïve type and are prone to being victimized by fraudulent acts.
Now that we’ve established that penny stocks are extremely volatile, high risk, speculative investments that are prone to misdeeds, what then, could be the reason why penny stock companies are on the rise nowadays?
The answer is simple. Take away the greedy people who are involved in perpetuating the scams and you’ll be left with companies that are honest, hardworking, and really worth looking-into. There are many great small companies today that are struggling to stay afloat. While they may not be worth much right now, they just might have what it takes to become tomorrow’s giants. Keep in mind that even the giants were babies once. This is what makes penny stocks worth looking into, and this is what helps the small-caps cross that bridge to get to the next level.
Another reason why penny stocks are lucrative is the fact that its a speculative market. Sure, a lot of people are uneasy when it comes to dealing with the unknown, but speculation is what keeps the penny stock trader going. It’s widely acknowledged that not all small-cap companies will make it to the next level. In fact, most penny stock companies might not even make it at all. But some will do. Some little-known, miniscule company with a lot of promise and backed by a team of headstrong hardworking people will definitely make it one day. The challenge, now, is for the investor/speculator to be able to identify which company that will be.
Playing with penny stocks isn’t like playing with fire, although that is exactly how the inexperienced investor treats it. It may be highly speculative, but it isn’t a game of Russian roulette either. In order for you to be successful at trading penny stocks, you must make sure to do your research. Find out as much as you can about a company you’re interested in before investing your money. Try to see if the company is doing well financially, or if it has any promise of being a leader in the future. Instead of listening to strangers or being attracted by the bright blinking lights that scream, “Hot Picks!!!”, focus on gathering information. After all, ignorance is never a good enough excuse.
It’s a given fact that in a highly speculative market, one can lose an insane amount of money. The opposite holds true as well. What makes the difference is the amount of time you are willing to invest in doing your research. If you can’t do your homework, not only are penny stocks not for you, but the whole stock market as well. Spending time to get to know what you’re getting into can be truly financially rewarding if you do it well.
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