Penny Stocks Pros & Cons

Penny stocks offer the promise of profits but also the risk of losses.

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Penny stocks are equities that trade below $5 a share. They are issued by companies that are too small to meet the listing requirements of the NYSE or NASDAQ exchanges, so they trade through the Over-The-Counter Bulletin Board or Pink Sheet electronic quotation systems. As a result, penny stocks don’t get exposure in the investing mainstream and stay hidden from most investors. Most penny stocks are traded through online brokers. Like other investments, penny stocks have pros and cons.

Get Rich Quick

Penny stocks’ major attraction is the potential to get rich quick. Penny stocks are issued to raise equity capital for small companies just entering their respective industries, companies emerging from bankruptcy or growing companies that are still flying below the investment analysts’ radar screens. Most penny-stock companies are small fry with big dreams, living in the backwaters of the investment world. But if they are discovered by the investing mainstream, the stock price could explode upward in a matter of weeks or even days.

Cheap Price

Penny stock shares are cheap, so an investor can buy a large holding for very little money. For instance if a company’s stock trades at 50 cents a share, an investor can buy 1,000 shares for just $500. If the price climbs to $2 a share, the investor reaps a $1,500 profit on his 1,000 shares. If the stock collapsed and became worthless, the investor would be out only $500.

Very Big Risk

Penny stocks are a perfect example of the old saying that great reward always entails great risk. Penny stocks are extremely risky speculative investments, and most investors who buy penny stocks make little or no profit. You are investing in small businesses that might not become profitable for years to come or that might never get things right and go bankrupt. Because these stocks aren’t tracked by the mainstream analysts and investment banks, it can be difficult to get company information needed for assessing a stock’s potential. Companies with assets under $10 million and fewer than 500 shareholders aren’t required to file financial statements with federal securities regulators.

Very Volatile

Penny stocks are traded in small lots among a handful of investors, which can exaggerate price swings. These stocks can shoot up in price very quickly but also drop in price just as fast. Penny stocks are not for the buy-and-hold investor or anyone with a low risk tolerance. Investors need to keep close tabs on their stocks and sell when they show a fat profit. Holding onto a penny stock too long can turn a tidy profit into a dismal loss. But the thin market for penny stocks may make it hard to find a buyer when you want to sell.

Penny Stock Frauds

Penny stocks are prime targets for fraudulent price manipulation and sham promotions because they are thinly traded, minimally regulated and unfamiliar to most investors. For example, the perpetrators of a scam may trade the stock back and forth among themselves to pump up the price, then dump the shares on other unsuspecting investors to garner a dishonest profit. Fraudulent stock promoters typically claim their company is onto some sort of “sure thing” that will generate big rewards with negligible risk.