Penny stocks are low-priced stocks – usually with a value of less than $5 – of small companies. These stocks are traded on the Over-The-Counter-Bulletin-Board (OTCBB) and the Pink Sheets. Both these trading venues do not have the same kind of minimum requirements of exchanges such as Nasdaq or the NYSE set by the Securities and Exchange Commission. Companies which issue penny stocks may be new businesses or close to bankruptcy. A new issue of stocks could be a way to inject quick capital to try to save the business.
All of these factors – low price, lack of standards, and lack of stability – make penny stocks one of the riskiest investments around. It is true that if a company succeeds the payoff will be great, but the vast majority of penny stocks end in bankruptcy. Other reasons why penny stocks are risky include...
- Lack of information about the company. Companies listed in the Pink Sheets or the OTCBB do not have to issue financial statements. Most companies also have little reportable history.
- Low liquidity. Penny stocks are infrequently traded, so finding a buyer may be difficult. The price may have to lowered substantially to interest someone in buying the stock.
- Potential fraud. Due to their unregulated nature, penny stocks are often used by con artists who sell them through spam email or off-shore brokers.
So penny stocks are risky but are there any benefits to them?
Not all penny stocks are frauds or companies facing bankruptcy. Some represent hard-working businesses that are struggling to meet the requirements to get listed on Nasdaq or the NYSE. Investing in these companies offers real growth potential – you have the opportunity to get in at the ground floor and ride all the way to the top.
The difficulty is finding which companies have this growth potential. Getting this information requires a lot of research and unless you are willing to take the time to personally investigate a company, you may again be the victim of fraud. Some companies specialize in offering 'inside information' about companies selling penny stock, but they may simply be fronts for pushing a particular stock on unsuspecting investors.
There are two ways to play the penny stocks – do research or play craps. The low cost of these stocks means that you will not lose a lot money if the company goes under, and as long as you are prepared to lose this money penny stocks can be an interesting and fun addition to any portfolio. It must be stressed, however, that penny stocks should only make up a small portion of any portfolio. The odds are that most penny stocks will end up in a total loss.
If you would like to buy penny stocks you need to find a broker that will place an order for you. Many brokers will not cover them because of the difficulties in tracking them, but some online brokers specialize in penny stocks. Regulations require brokers to receive written confirmation from the client concerning the transaction. The broker is also required to give the client a document outlining the risks of speculating with penny stocks.
Finally, the broker must disclose the current market price of the stock and the amount of compensation the firm receives for the trade. Monthly statements must be sent to the client detailing market value of each penny stock in the account.
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