Author: Izabela Szkaradek
Publication date: 19.09.2023
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Penny stocks have become popular among investors looking for financial opportunities beyond mainstream stocks. Not only are they low-priced, but they also look like a means of quick money gain. However, it’s crucial to understand the risks and rewards of penny stocks. The reason for this is the fact that penny stocks are both high-risk and high-reward investment strategies.
What Are Penny Stocks?
Penny stocks are the shares of small companies that are not listed on major stock exchanges. What’s important is that companies usually struggle with having limited market value.
Some of the stocks can be found on large markets such as the New York Stock Exchange (NYSE). However, most of them are traded via over-the-counter (OTC) transactions, or on the electronic OTC Bulletin Board (OTCBB) system.
Risks Involved With Penny Stock Trading
When thinking of investing money in penny stocks, you need to be aware that they are riskier than regular stocks. There are 3 main factors which make this form of investment unsafe.
Scams
The penny stock market is full of scams. That’s why it’s important to be aware of fraud so that you can avoid them. Pump-and-DumpSchemes are one of the most common ones.
In fact, it entices inexperienced investors to buy shares and drives up prices. They do it by generating excitement around a lesser-known company. When the stock reaches a significantly inflated level, individuals sell it for their own profits and leave investors with losses.
Low Liquidity
In penny stock trading, a significant concern is based on the limited liquidity of these
stocks. This means that it experiences lower trading activity and volume, making it challenging to buy or sell orders at your desired time. This can become problematic, particularly if you need to exit a trade quickly, as you might struggle to find a willing buyer.
As you wait for another party to complete a trade with you, the stock's price might increase negatively.
Low Trading Volume
When considering investing in penny stocks, remember that your investment only becomes profitable when you sell it.
For example, you buy a stock at $2 per share and its price rises to $100. Until you actually sell the stock and have the proceeds in your possession, the $98 increase remains theoretical.
Rewards of Penny Stock Trading
Even though the penny stock market is full of risks, it also can be a way to make money. Of course, only when you are willing to take a risk. Here are 2 potential rewards of trading penny stocks.
High Returns
When a company's stock is priced at just a few cents per share, even a one-cent change in the share price can give you a decent percentage return. For example, if a stock is at ten cents, it only needs to go up by one cent to give you a 10% return. This is because small and fast-growing companies can change their fortunes quickly, even a small investment could turn into a significant gain.
Low Cost
Another example of penny stock rewards is that they have a low cost. This means investors don’t need much money to invest. Due to that, they’re accessible to a broader range of investors due to their affordability. For instance, if a company’s share is $1, an individual would need $100 to buy 100 shares.
Advice for Buying Penny Stocks
If you are aware of the risks, there are the 3 most useful suggestions for buying penny stocks. First of all, decide how much you can lose. In view of this, it’s better not to invest all of the savings in penny stocks.
Also, look out for “fallen angels”, which could be solid companies having a bad time. You can do it by doing plenty of research and being aware of scams. Last but not least, watch out for the letter Q at the end of a stock ticker as it means that the company is in bankruptcy.
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