What Are Penny Stocks? An Overview and Interesting Facts

The dollar signs people imagine with penny stocks is a little bit of fact and a lot of fiction. Learning the limitations of penny stocks will help you to appreciate their real value. Penny stocks are valued at less than five dollars, so there are many ways to capitalize on their low buy-in. But is it worth the risk involved, and do you have enough information to make it profitable?

They Are Not A Get Rich Quick Scheme

Penny stocks are not a scheme that will get you the most money possible in the shortest amount of time. Hollywood glamorizes it to make penny stock investments look easy. Millions of investors that have failed before you will say otherwise. There are winners and losers with every type of stock, and penny stocks are no different. They just so happen to cost a lot less than normal stocks, so tend to be an attractive buy for beginning investors. Penny stocks come and go like the wind, so you never know what the next hour or day will bring. By getting wrapped up in the idea that it is a simple gamble, you could lose your life savings very quickly.

There Is A Lot Of Risks

The risk is high for penny stocks, no matter what news you hear. Some companies that are evaluated as a penny stock are not required to file with the SEC. The Security and Exchange Commission is vital to ensuring the wealth of millions, so yes, it is a big deal. There is no ‘backup plan’ with a penny stock, and any of your logical conclusions will just be educated guesses. You also have to question whether your research comes from a reputable source. Bad information on a penny stock could force you to buy when you should be avoiding it altogether.

Not All Penny Stocks Move Fast

Staring at the current price of a penny stock will not magically make it change to a higher number. Not all of these companies are volatile, so don’t expect all of them to rise and fall at a moments notice. You can spend weeks holding your position and still find it unwise to move with some penny stocks. Accurate 52-week data from the company may show possible trends, but the truth is that most penny stocks gain or lose value regardless of their historical data. It is the ultimate aggravation for day traders that are looking to make a quick couple of bucks.

There Are Good Companies Behind The Stocks

Don’t make the mistake of assuming that penny stocks are all fledgeling companies that lack attention. Everyone starts somewhere, and there are even big value companies that are recovering from being a penny stock. The same respect you give to a regular stock should be applied to penny stocks, especially when deciding on investments. Think about it logically- if you thought ‘less’ of the company behind the stock, why would you put money into it? Buying a penny stock isn’t doing a company favours since they are not charity cases. For a good idea of some of the current winners, read more here. When you make the decision to buy, make sure you are giving the company its proper due.

Investors Are More Likely To Lose Money

At this point, everyone that has heard of penny stocks knows about the risks. But somehow, there are still people out there that think they have a special formula. Think about the last few times you went to a casino and beat the house. Now imagine winning even less than that when it comes to penny stocks. It isn’t uncommon to invest a couple of bucks into a penny stock and then be sent a check later in the year when the company folds. More investors lose money on penny stocks that make money. A lot of the stats being thrown around includes wide-eyed beginners, so the results are a bit skewed.

The Market Has Unfair Regulations

Now, this is a bit of a controversial take and has been parroted for years by many sides. But penny stocks aren’t held to the same standards as regular stocks. Penny stocks don’t have to follow the same rules as all of the big boys, so they can make moves that toe the line between legal and illegal. As scary as it is to have stocks with a different ruleset, it is necessary so that penny stocks can grow. Think of the different set of regulations used for penny stocks as a virtual ‘training wheel.

Pump And Dump Scams Are Real

A pump and dump inflate the price of a stock by releasing false information. Penny stocks are the perfect target for this fraud since they are easy to buy up in bulk. With a little bit of good marketing, that same stock triples in price (even though it is not worth nearly as much). Once that happens, the buyer sells the stock at the higher price and makes out like a bandit. Unfortunately, not long after that, the stock you just purchased for the higher price goes back down to its original value, sometimes less. The internet has made it easier than ever to spread false marketing, so buyers should be careful of pump and dump scams involving penny stocks.

A Diamond In The Rough

Even with the risk, every portfolio should have a penny stock. Finding that special company and being there from the beginning is a great feeling. Imagine the people that were there from the start for Apple, Microsoft, Netflix, Amazon and other big-time companies. Everyone has to start somewhere, and a penny stock is one of several ways to show your interest.

Wrap Up

If your imagination is bigger than reality, then penny stocks will be a bad investment. But for buyers that respect a mature market, penny stocks are a goldmine. Take the time to figure out which category describes your personality. There is potential with penny stocks, but only in the hands of those willing to understand the system. If you’re interested in investing a little more money to increase your cash flow over the medium-term, there are plenty of articles that show you how to achieve above-average returns for your investing efforts. Forget about traditional stocks and bonds — check out these little-known best ways to invest 10000 instead.