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What are Penny Stocks? Everything you Should Know Before and After Investing

Mansurat is a personal finance writer. Her articles provide valuable insights on saving and investing.

What Are Penny Stocks?

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All You Need To Know Before Investing

Lately, there has been a huge buzz around penny stocks and a lot of people have been wondering what they are and how profitable investing in them can be?

Penny stocks like the name implies are stocks put in the stock markets by budding companies and their initial public offerings are often very little.

They are stocks that are worth pennies. Yet, with the right guidance and knowledge, a lot of money can be made by trading and investing in these shares.

In line with that, this article will be covering all the basics you need to know about penny stocks. From what they are, to trading, investing and invaluable lessons to learn to master the game around penny stocks.


Penny Stocks Definition


Penny stocks are shares belonging to small companies put out to the public at a price of fewer than five dollars. They can be traded via securities exchanges like NYSE or over-the-counter exchanges like OTC Bulletin Board.


The market capitalization for penny stocks is low compared with the market capitalization of stocks with higher prices. Penny stocks are very volatile and most investors acquire them in large amounts. However, its liquidity tends to be on the low side.


Types Of Penny Stocks


There are different types of stocks and similarly, there are different types of penny stocks. Broadly, penny stocks can be categorized based on volatility and trade volume. A penny stock could be highly volatile with a high trade volume or it could have low trade volume. These are important factors to consider when investing in a penny stock.


Highly Volatile and Stable Penny Stock


A highly volatile penny stock experiences a continuous change in price usually in an increasing fashion. A stable penny stock on the other hand

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rarely experiences price changes. This translates to having very few buyers, investors, and traders. When investing, high volatile penny stocks should be favored as they have the potential to get you huge returns on your investment as opposed to the low volatile or stable penny stocks.


High Trade Volume And Low Trade Volume Penny Stock


Trade volume is an indication of market emotion or interest. A high trade volume penny stock has a large number of trades being executed daily. A low-volume penny stock is barely traded and this shows that very few people have invested in the penny stock. This is also another important factor to consider. You should only invest in penny stocks that have a minimum trade volume of 200,000 every 24 hours. Before going for penny stocks with trading volumes higher than this, you will need to be prepared to manage the potential loss or risks associated.


Where And How To Find Legitimate Penny Stocks


Finding legal penny stocks is one thing, finding a legitimate place to purchase and store them is another. There are a myriad of penny stocks as well as exchanges but caution must be taken in order not to get scammed.


Legitimate penny stocks belong to traceable companies with enough credentials and information. This way you will understand what they do and why their stocks are worth investing in. Although, they may not be so easy to filter out.


Things To Look Out For In Legitimate Penny Stocks


Satisfactory information about the company the stock is from must be readily available.

The stocks should not be dubiously promoted.

Its price should not be directly dependent on marketing noise.


Things To Look Out For In Legitimate Exchanges


Their charges are not based on shares but rather fixed.

They have enough information to prove legitimacy.

A legitimate exchange should have enough positive reviews.

The reviewers should not be company insiders or paid reviewers


In all, the go-to exchange platforms are huge names like the NYSE and NASDAQ. Also, an easy way to vet a penny stock is to check if it is available on these platforms. Penny stocks listed on these two sites are worthy of investing in as they often have high trading volumes and are volatile.


Trading And Investing In Penny Stocks


Before jumping headlong into investing in a penny stock, you must first make findings of the stocks available, the one you will be going with, and the risks involved. The major downside to investing in penny stocks is their low liquidity which sometimes leaves traders caught up in a trade.


All trades are accompanied by risk so all that is needed is to find a penny stock with a reasonable level of liquidity, volatility, and trading volume. Once all of this is done, the next step is finding a suitable brokerage company to go with.


All brokerage companies have different policies so reading up and checking out available reviews is the first smart step. There are loads of penny stocks priced below one dollar and often only available via over-the-counter exchanges. Stocks below one dollar and over-the-counter exchanges must be properly screened before putting any money to invest.


Penny Stocks over one dollar up to a little below five dollars will be available via big exchanges like NASDAQ. They tend to be more favorable for investors. The bottom line is making findings of the broker beforehand.


Are Penny Stocks High Risk?


The simple answer is a straight yes. Penny stocks are high risk. They pose more risk when compared to regular stocks.


Several people erroneously believe since penny stocks are cheap, they will be less risky. This conclusion is drawn without properly considering the amount that would be invested at the end of the whole day. So what makes penny stocks so risky?


Penny stocks are risky because they are worth pennies and it often creates an illusion that saves them from proper scrutiny making it easy for investors to fall for scams. Most penny stocks are transacted via over-the-counter exchanges and are most likely never vetted by the securities and exchanges commission. This implies that most of these stocks are unregulated. However, penny stocks that meet the requirements of big exchanges are publicly verified and less likely to be scams.


Another reason why penny stocks tend to be riskier is the fact that they are owned by budding and start-up companies with very little record. Based on this, determining the success of a penny stock can be a huge deal.


Also, the price of penny stocks is easily manipulated by promoters and the companies themselves. This makes certain stocks look like they are worth investing in when they are not.


This does not in any way mean that all penny stocks are not safe for investment. All that is needed is prior research as nothing is hidden with research and making well-calculated and informed buy decisions.


How Often Do Penny Stocks Fail?


Most of the time, people who make lots of money from investing in penny stocks are well informed. They go for stocks with a good liquidity level so they don't get stuck in trades and they monitor the trade volumes as well as volatility levels closely.


The hard truth is most penny stocks fail because most businesses fail. To be successful with penny stocks investing, a lot of consideration about the company, its policy, and growth potential must be taken. The survival of a penny stock is tied to the company's success and this is what creates the notion that penny stocks are not worth investing in.


A little bit of research on the company's business model must be done. Companies in their first three years may be difficult to analyze but from four to five years and above should be easier. If the company is not making any form of arithmetic or geometric growth, there is every likelihood its stock will perform similarly and fail.


Can You Get Rich From Investing In Penny Stocks?


Yes, you can and anyone can. Investing in penny stocks may look tricky and very risky but it can be very rewarding. There is a relatively long list of successful penny stocks. Apple inc. stocks once traded as penny stocks and they have become very successful. True religion jeans is another penny stock that has become successful.


Investors who had invested in these stocks in their early phases when the shares were less than five dollars have made a lot of returns on their investment. There is no formula for investing or a way to calculate how much returns you would get in the end. However, it is very possible to get rich from investing in penny stocks but you would have to be very calculative and sensitive to the market charges


These three stocks are available on securities exchanges hence they are verified and safe.


Conclusion


Penny stocks have proven to be a great investment for several people. Like any form of investment, attention must be paid to the basic rules surrounding it to be successful. With adequate research, penny stocks can yield a high return over time.



This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.

© 2021 Mansurat Zakari

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