Wed. Jun 7th, 2023

The Risks and Pitfalls of Penny Stocks

Penny stocks offer an excellent way to speculate with a low investment risk and potential returns. But before investing in penny stocks, make sure that you fully understand all of their associated risks and pitfalls.

Have you ever read or seen TV stories of investors buying penny stocks that double in value, seemingly overnight? Though this seems incredible, such stories do happen from time to time.

They are speculative

The penny stock market is an unpredictable trading environment that offers unreliable trading conditions and stocks that could go up in price; however, this is no guarantee and could never happen; additionally they can also be vulnerable to scams and manipulation.

Pump-and-dump schemes are one of the most prevalent forms of manipulation, often used by scam artists to take advantage of investors and sell off shares at huge profits to unsuspecting buyers at a profit. Such scams should be taken very seriously by investors as it could cost them an enormous sum of money in return.

Penny stocks present additional risks beyond fraud, however. First and foremost is their small size; therefore they often lack resources that enable them to compete against larger businesses, leading them down a path toward decreased market capitalization and market cap losses.

Another key consideration when investing in stocks is the number of shares traded per day. When there are more trades taking place daily, stocks become more volatile as investors can quickly influence the prices up or down quickly.

With these highly-speculative companies, it is wise to wait until the right moment comes along before investing. Doing this will allow you to maximize your return while limiting losses beyond what can be afforded.

Utilizing tools like the Relative Strength Index or Stochastics can assist in determining if penny stocks are overbought or oversold, providing insight into whether the penny stocks have reached overbought or oversold levels. Furthermore, such tools can also assist when trading sideways markets when it is difficult to predict where penny stocks will move next.

When selecting an ideal penny stock, it is crucial that you look for an established business model and a management team with proven growth and profitability credentials.

See also  What is an Investment Firm?

Penny stocks offer traders looking for quick returns an excellent opportunity, but must be chosen with caution as they are extremely speculative and may see dramatic fluctuations. Furthermore, it is crucial that a stop-loss or profit takeoff plan be established when taking on penny stocks as investments.

They are traded over the counter

Penny stocks are most often traded over-the-counter (OTC). These securities do not trade on major exchanges like Nasdaq or New York Stock Exchange and therefore tend to be less regulated and more speculative than traditional markets.

OTC stocks tend to have low liquidity, making it harder for investors to sell them at the right time or find someone willing to pay the price they desire – this is due to OTC markets not offering as many trading volumes.

Lack of liquidity in penny stocks can also result in wide bid-ask spreads that cause big swings in prices of the stocks, which could be especially risky if you are trying to sell at high prices.

One of the most widely traded penny stocks are those listed on OTC Bulletin Board or Pink Sheets. Companies listed here do not need to register with Securities and Exchange Commission but must comply with certain regulations.

As these companies often lack historical data or proof of business performance, investing in them may be considered risky.

Many are drawn into penny stocks because of the promise of quick gains in a short period. Unfortunately, this doesn’t always pan out; on average, penny stock gains range between 5-11% per stock.

Penny stocks tend to be shell companies. These non-existent businesses have not filed their financial statements or updated their websites in years, leading investors to suspect them of not being genuine businesses.

In order to reduce this risk, it’s imperative that you conduct proper research. Investigate the company’s history, management team and where their shares trade – this will give an in-depth view into their ability to run smoothly as well as any future plans they might have for expansion or growth.

If you’re planning on purchasing penny stocks, it is wise to select a reputable broker. They will assist in navigating the OTC market while protecting your investments with low fees, short locates, spreads and commissions.

They are a scam

Penny stocks offer investors an effective means of diversifying their investments while taking significant risks. Unfortunately, penny stocks often fall victim to scams that may rob them of all their funds and leave them financially devastated.

See also  The Investment Return and the Real Rate of Return

Penny stock investors should beware of pump and dump schemes, which involve spreading false information that causes an upswing in buying activity, only for it to collapse later and cost investors dearly. This practice can lead to devastating returns.

Chinese companies that operate without any regulatory oversight are notorious for engaging in fraudulent practices that allow them to falsify earnings and defraud honest Americans. These schemes often employ accounting tricks designed to create artificial earnings reports while at the same time taking money out of their bank accounts illegally.

Fraudulent companies can be hard to spot due to a lack of regulation on lower priced stocks, making it easier for fraudsters to take advantage of unsuspecting investors.

Fraudsters frequently employ cold calling tactics to convince investors to invest in their stock, often by hiding behind technology that masks their true locations and identities.

For your own protection from penny stock scams, always remain extremely wary and skeptical of anyone contacting you via telephone. Never answer the call from these individuals nor respond to their sales pitch.

Avoiding scams like this one requires conducting your own research and seeking advice from experienced investors. Also be mindful that high-volatility stocks could result in you losing all your investments quickly.

Other penny stock scams exist as well, such as company awareness campaigns that distribute false news to attract investors – often promoted by promoters who receive payment to do so.

Brokers that try to convince investors to purchase stocks at reduced prices often spend weeks or months trying to earn your trust; often convincing you they are reliable brokers.

Scams of this nature are extremely prevalent and it is wise to remain wary. Their potential damage to your finances and future could be devastating.

They are profitable

Penny stocks offer an attractive way to generate income; however, they are also risky investments that require careful research before being invested. Only invest what you can afford to lose.

Penny stock trading requires several strategies that can help maximize your investment returns, with candlestick chart patterns being one such technique commonly employed to predict price movements in the future.

See also  The Benefits of an Investment Grade Bond ETF

Establish price triggers on trades as another strategy to remove emotion from trading and promote discipline in your plan. This can help eliminate many trading impulses while providing consistency to your plan.

Penny stock traders also rely heavily on fundamental and technical analysis when selecting stocks to buy or sell. While fundamental research can help gain a comprehensive view of a company’s finances and future performance, technical analysis helps identify patterns in price movement so as to know when and why to buy/sell shares.

Penny stock investors should utilize technical analysis tools as part of their investment strategies, but these analyses alone cannot ensure success with penny stocks trades. With an understanding of fundamentals and proper application of technical analysis techniques, penny investors may have great success trading penny stocks successfully.

Keep in mind that penny stocks often change quickly over a short period of time, necessitating quick decisions in order to prevent potential losses.

Before purchasing penny stocks, there are a few important factors to keep in mind, including their float, short interest, and relative volume. A company’s float is defined as the total number of outstanding shares traded publicly – so having a lower float could indicate faster movement from investors than others while having more investors trading your penny stock could provide greater liquidity when entering and exiting positions.

Penny stocks offer investors looking for their first investment an easy and accessible way to start building a portfolio with relatively modest capital. Trading over-the-counter markets makes investing simple. When choosing your broker it’s recommended you look for one who offers low fees and strong trading platforms as this will increase your odds for success.

Jeffrey Augers
Latest posts by Jeffrey Augers (see all)

By Jeffrey Augers

Jeffrey Augers is a highly skilled and experienced financial analyst with over 12 years of experience in the finance industry. He has a proven track record of delivering exceptional financial insights and recommendations to clients, empowering them to make informed decisions and achieve their financial goals. Jeffrey holds a Bachelor's degree in Finance from the University of Michigan, and an MBA from the Wharton School of Business.