What Are Penny Stocks?
Penny stocks are classified by the SEC as stocks that trade for less than $5 per share, says Josh Simpson, a financial advisor with Lake Advisory Group.
Typically, penny stocks are the shares of troubled companies with very small market capitalizations. There is no registration for penny stock on major stock exchanges. While there may some registration a few on the NYSE or the Nasdaq. Most of them are traded via over-the-counter (OTC) transactions, or on the electronic OTC Bulletin Board (OTCBB) system. They are ready for high volatility, wild price swings, and fraud.
Risks of Penny Stocks
Few penny stocks are like Nautilus. However, they tend to carry a much higher risk than stocks that trade on major exchanges. This makes it easier to lose money, no matter what the size of your investment. As Forbes states, there are risks that u have to be aware of when dealing with penny stocks:
High Price Volatility
Because penny stocks have low prices, “just a small move in the stock price can represent a large percentage gain,” says Tyler Hardt, chartered financial advisor (CFA) at Pelican Bay Capital Management.
A move from $0.50 a share to $1.00 a share might not look like much at first glance, but it’s a 100% gain. But by the same token, when things go bad, they go bad fast. A small absolute loss could represent a significant percentage loss.
Most investors can’t handle that much volatility.
Unproven, Opaque Companies
Penny stocks are usually lesser-known companies without proven track records. They may have lower reporting requirements, making it difficult to adequately research them before investing.
Investors can get plenty of financial data other than required reporting to see how companies have performed. With it, you may be buying blind or be forced to invest large amounts of time researching them.
Low Trading Volume
When you buy stock on the Nasdaq or the NYSE, there is a very large market filled with buyers ready to purchase any amount of shares. If no single buyer wanted all your shares, a brokerage or market maker would take your stock because they know they’ll be able to find buyers later.
Things are different with penny stocks, whether they’re listed on major exchanges or traded OTC. Trading volumes in this stock are very low, with few buyers or market makers.
“Even if that stock you bought for $0.10 is now worth $0.75, you can’t sell it unless there is another investor who is willing to buy it from you,” says Simpson. You may be making profits on paper with this type of stock, but you might not be able to realize your gains.
