Penny stocks are often an appealing way to cheaply invest in the stock market. While there are some benefits to trading in penny stocks, you’ll also need to be aware of the risks involved. Here are the pros and cons of investing in penny stocks.
What Are Penny Stocks?
Before you can decide if investing in penny stocks is the right financial choice for you, it’s important to understand how they work. Penny stocks are shares of an up-and-coming company’s stock that usually trade for less than $5 a share. Some of these types of penny stocks may trade on the New York Stock Exchange, but over-the-counter (OTC) stocks, micro-cap stocks, and nano-cap stocks can trade for less than $1 per share. As you start out trading penny stocks, here are several advantages and disadvantages to know about.
One extremely attractive feature of penny stocks is the exciting potential to make a large return. Many small and newly growing companies sell shares in penny stocks, and it’s definitely possible to find some of these companies with the potential to grow quickly. The key to finding these worthwhile company penny stocks is to look within industries with expected growth and demand for the companies’ products or services. For instance, technology or pharmaceutical penny stocks are industries that have the potential to grow.
Penny stocks got their name due to the low price threshold of these types of shares. While the penny stocks that trade on the large markets may trade for up to $5 a share, the majority of penny stocks, OTC stocks, and micro-caps trade for pennies. So if you have $500 to invest in stocks, instead of buying only two or three stocks of a company’s shares, you can buy hundreds of penny stocks.
It can be extremely risky to trade in penny stocks because they are essentially speculative investments. This is because you’re investing in small companies and businesses that may not prove to be profitable until well into the future, or worse, never grow at all. Additionally, the United States Securities and Exchange Commission and many investment banks will only track companies that have more than $10 million in assets and more than 500 accredited shareholders. This makes it difficult to assess a small business’s stock potential, resulting in a very big risk if you decide to throw everything into penny stocks.
Potential for Scams
Because penny stocks aren’t heavily regulated through the U.S. Securities and Exchange Commission, there is a high potential for fraudulent scams that you need to be alert for. As you get into penny stock trading, be aware of scams that talk up a company’s cheap share as if it’s going to prove a huge profit. This is an example of what’s known as the pump-and-dump scheme, which is one of several ways that scammers have used penny stocks.
Trading in penny stocks can be fun if you’re willing to practice with your pennies without expectations of huge profits. It’s also important to take the time to learn more about stock trading as you go, so you can make bigger investments later.