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When you see stocks like Amazon and Google’s parent company Alphabet trading at thousands of dollars, investment seems out of reach. These high prices may entice you to look for bargains. Enter penny stocks.
Low-priced stocks seem to be an opportunity to buy a budding company at a very low price. For the price of the stock, you can buy hundreds or even thousands of shares.
But be warned: trading low-priced stocks can easily bankrupt you. This is why it is easy to lose money by buying low-priced stocks.
What are penny stocks?
The U.S. Securities and Exchange Commission defines penny stocks as stocks that trade at US$5 or less per share. However, most investors have a narrower definition. Many people define it as a product whose transaction price is less than $1.
Low stock prices are not the only factor that defines a penny stock. You can find stocks that cost less than $5 per share on major stock exchanges such as Nasdaq or the New York Stock Exchange (NYSE). But most investors don’t think these are low-priced stocks.
Penny stocks are usually traded on the over-the-counter (OTC) market. The transaction takes place between the broker-dealer of the buyer and the seller. They use the over-the-counter market to name prices. Without a central exchange to facilitate transactions, this may happen without anyone else knowing the transaction price.
The feeling of trading may be the same as when you were trading Invest in stocks Listed on major exchanges.You can usually use any Brokerage account You usually use it to trade stocks. You place an order in the same way as any other inventory.
The only thing that might stand out is that the SEC requires your broker to get your signature on the risk disclosure document before placing the first penny stock order.
The market value of penny stocks—which means the total value of all publicly traded shares of the company—is less than $300 million. To be included in the Standard & Poor’s 500 Index, which is generally regarded as a barometer of the US stock market, a company’s market value needs to be at least $11.8 billion.
Are penny stocks worth it?
If you want to know, “Are penny stocks worth it?”, the answer is almost resounding, “No!” This is why penny stocks are one of the riskiest investments you can make.
Lack of transparency
Large companies that trade on major stock exchanges need to submit a lot of information to the SEC.The information is published on U.S. Securities and Exchange Commission.
However, suppose you enter the penny stock market by investing in a company with less than $10 million in assets and only 2,000 individual investors. The company may not need to file with the SEC at all. In addition, investment analysts and news reporters scrutinize larger listed companies carefully, while paying much less attention to smaller companies. A company with assets of less than US$10 million is unlikely to attract too much attention.
Compared with companies on large stock exchanges, companies trading on the over-the-counter market are subject to much less supervision. Many penny stocks are traded on pink sheets, an electronic stock listing service, because it was once published on-you guessed it-pink sheets. The companies listed on the fan list do not need to disclose much information.
Few minimum listing requirements
Any stocks traded on major exchanges are subject to strict requirements. For example, to start trading a stock on the New York Stock Exchange, these are just some of the requirements:
- At least 400 shareholders, each owning at least 100 shares of the company.
- At least 1.1 million publicly traded shares with a value of at least US$40 million.
- The stock price must be at least $4 per share.
Companies that issue low-priced stocks often cannot meet these stringent listing requirements.
Maybe they don’t have a verified record. Low-priced stocks are usually issued by companies that have never made a profit.
Or maybe they do have past records, but this is a troublesome record. If a stock listed on the New York Stock Exchange or Nasdaq drops below $1 per share and stays there for a long time, it will be delisted. Then, you will see it on the over-the-counter market.
High volatility
Penny stocks are a highly speculative investment. A piece of good news or bad news can determine your investment in a penny stock. These companies are so small that their success may depend on obtaining FDA approval for a single drug or obtaining a patent. Relatively small changes in stock demand can also result in significant gains or losses.
When your stock price rises from a few cents to a few dollars, you can make huge profits. At the same time, for major stocks, if the price increases by a few dollars, it will not bring huge returns.
But remember: it is very difficult to find good quality low-priced stocks because they are issued by unproven or troubled companies. The probability that the price drops to zero and you lose your entire investment is much greater than the probability that you become rich.
Low liquidity
Most penny stocks have low trading volumes. This means they are rarely traded, which is bad news for you when you want to sell.
Suppose you own 5,000 shares of a company, but the daily trading volume is only 1,000. In fact, you have to wait five days before you can sell all the shares. Even so, you may have to sell at a price well below the asking price.
In investor terms, this is called low liquidity: to quickly convert your investment into cash, you will most likely have to sell it at a low price and lose money.
Riddled with fraud
The world of penny stocks is full of fraudsters who prey on inexperienced investors. The two most common penny stock scams are skyrocketing and plummeting and shorting and twisting.
Pump and dump scheme: The scammers hyped up a company to push up the stock price. They might say that a company has found a cure for COVID-19, or it has discovered a new gold mine. Then, they sold the inflated stock to unsuspecting investors.
You might find scammers hyping a particular stock in penny stock newsletters, message boards, or research that seems legitimate. Another common strategy is to call on investors to become interested in penny stock companies, as happened in the movie “The Wolf of Wall Street,” which is based on the true story of the discredited stockbroker Jordan Belfort.
Short and twisted: When investors bet that the value of a stock will fall or become worthless, they use a strategy called short selling. When you short a stock, you are actually borrowing the stock, hoping that the price will fall. Then you can buy it back at a lower price to close the position. By shorting and twisting scams, fraudsters short stocks and then spread false negative rumors about the company. When the stock price plummeted, they made a profit.
But can’t I choose the next Tesla?
In theory, yes. But this is extremely unlikely. Most very successful companies have never traded as low-priced stocks.
Microsoft, Amazon, Facebook, and Tesla all made huge profits for early investors. But they have been mainstream stocks from the beginning. They have been trading on major exchanges from the beginning, and the initial public offering (IPO) price of each exchange is above $15.
If you decide to trade penny stocks, please follow 6 rules
We hope we have convinced you that buying low-priced stocks is not worth the risk.You are more likely to invest in ETF or Mutual Fund Represents the entire stock market.
But what if you are determined to do so anyway? Follow these rules to reduce risk.
1. Only invest in losses you can afford
Can you accept losing this money at the poker table? If the answer is “no”, please do not invest it in low-priced stocks. Your chances of losing money are much higher than your chances of making big money.
2. Research before buying
If you are unable to obtain information about the company from the SEC file, it indicates that you should choose a different stock. Also, make sure you understand the basics of the industry and how the company makes money. A little bit of knowledge will help you see the over-promotion driven by the promoters of low-priced stocks.
3. Look for stocks with good market capitalization
Most low-priced stocks are either nano stock companies (market capitalization of US$50 million or less) or micro stock companies (market capitalization of US$50 million to 300 million). To reduce risk, look for stocks with market capitalization at the high end of the range.
4. Pay attention to transaction volume
The stock trading volume shows the number of stocks bought or sold on a specific date. Look for low-priced stocks with a minimum trading volume between 100,000 and 200,000 to increase the chances of willing buyers when they need to be sold.
5. Use automatic stop loss triggers
If you decide to buy penny stocks, you may need to set a stop loss trigger. If your stock price drops by the amount you specify, your broker will automatically list it for sale. But remember: low liquidity can make it difficult to sell low-priced stocks.
6. Use no more than 10% of the investment portfolio for high-risk investments
The absolute maximum value of high-risk investments should not exceed 10% of your investment portfolio. This is 10% of all venture capital.You won’t get 10% penny stocks, 10% bitcoin, and 10% investment Cannabis stocks.
Keep the other 90% in one Diversified investment portfolio Invest in the stock and bond markets.
Want to buy cheap stocks?Consider this alternative
If you want to start investing but don’t have much money, you can consider buying Fractional shares Rather than low-priced stocks. You decide how many stocks you want to invest in, and then you get the corresponding share. If Amazon’s transaction price is $3,000 per share, and you invest $30, you will get 1/100 of the shares.Many mainstream brokers and Investment application Partial investment is allowed.
Bottom line: Before investing in penny stocks or anything else, please be aware of all risks. If you cannot afford to lose money, it is best to avoid penny stocks.
Robin Hartill is Penny Hoarder’s certified financial planner and senior writer.Send your tough money questions to [email protected] Or chat with her Penny Hoarders Community.
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