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Saturday, April 02, 2011
Investing in Penny Stocks
One of the questions that frequently comes up in stock investing is "What's a penny stock"? The term "penny" seems to suggest that the stock sells for a penny. However, in the US, the price of such stocks need not be a penny but generally penny stocks tend to have a stock price of under $1. However, there's no standard definition with respect to the stock price and some people even consider stocks trading under $5 as penny stocks. Regardless of the price, the key thing about a penny stock is that the term generally refers to a stock that is highly speculative and risky since such stocks typically are thinly traded and have low liquidity. Penny stocks also typically do not trade on the major stock exchanges such as NASDAQ or NYSE. Rather they trade in the over the counter market through pink sheets and OTC Bulletin Board (OTCBB).

Many novice investors get attracted to penny stocks thinking that they can make huge payoff by investing just a small sum. It's true that due to their very low stock price, you can get a lot of penny stock shares for a small investment. However, the fact that they will yield high payoff may not be true. As mentioned, penny stocks are highly speculative and since they are thinly traded, rumors about such companies can greatly impact their stock prices, making them a very risky investment.

Other things to keep in mind related to the investment in penny stocks include:

1. Penny stocks are typically stocks of very small companies that may not have sufficient cash and other resources to tide over changes in business conditions. As a result, such companies can have a high probability of going under.

2. Since these stocks are typically not traded on major stock exchanges, they may not be subject to same stringent listing, regulatory, and disclosure requirements as the companies that trade on major stock exchanges. In addition, not sufficient information may be available related to the financials of such companies.

3. Due to thin trading, the bid-ask spread of such stocks can be large. As a result, not only you end up paying a high price when buying, you end up doing the same when selling.

4. Due to their low trading volumes, prices of penny stocks can be relatively easily manipulated by unscrupulous people who may buy/sell large number of shares and spread rumors about such stocks with the aim of solely influencing the stock price.

5. While you can get many shares of such firms for a very small investment, a series of such losses over time can add up and result in big losses.

Apart from the above considerations, penny stock investors need to be aware that since these stocks are thinly traded, most research analysts typically do not follow such firms. As a result, there is typically limited research information available about such firms. Sure, there are many resources on the Web that cater to penny stock investors, including penny stock newsletter, groups on major internet portals, and so forth. However, even with such resources, investors need to realize that they are primarily on their own and not rely completely on the recommendations of newsletters, internet groups, and so forth since some people may use such resources to manipulate the prices of penny stocks.

In conclusion, be aware of the above mentioned things when thinking about investing in penny stocks. And if you do thorough research and are not afraid of losing your investment, you may indeed sometimes uncover good opportunities since sometimes, even established firms can temporarily end up trading on pink sheets and OTCBB because they failed to meet the listing requirements of major exchanges.


Note: The above is a paid post.

The above post is not a recommendation for investing in stock market. Investment in stocks can be very risky, and you need to rely on your own judgment and discretion. Please also see Disclosures and Disclaimer
posted by Ruby @ 7:55 AM  
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