What is a Penny Stock and What Are the Pros & Cons Of It?

Penny Stocks are equities or stock traded by a small company for less than $5 a share. While some penny stocks to trade on large exchanges such as the New York Stock Exchange (NYSE), most penny stocks are issued by companies that are too small to meet the listing requirements of the NYSE or NASDAQ.

Thus, penny stocks are often traded through the over the counter (OTC), via online brokers in the electronic OTC Bulletin Board (OTCBB) or privately-owned Pink Sheet electronic quotation systems. They are still monitored by the SEC or the Security and Exchange Commission, an independent federal government agency responsible for safeguarding investors and maintaining the fair and methodical function of the securities markets.

Due to their size and the fact that they stay away from the trading floor, penny stocks are often unknown to mainstream investors. As with everything, penny stocks have their pros and cons, but either side of the coin couldn’t be more different in this case. You should evaluate them to decide whether you are willing to take the risk. Let’s explore them a bit further:

Get Rich Quick

The biggest draw of a penny stock is the potential to get rich quick. Penny stocks often come from companies that are just entering the industry and need capital, which means they’ve yet to be discovered by investment analysts and the like. Companies emerging from bankruptcy and those that are still growing may also issue penny stocks.

These are the business who are still small but have big dreams (and potential). But the best probable outcome with these companies is that they could be discovered by the mainstream market any day, and if/when they are, the stock price could explode in a matter of weeks or even days!

Cheap Price

Perhaps the biggest advantage of penny stocks is that they are so cheap. An investor can gain a large part of the equity of a company by investing a considerably small amount. For instance, if a company’s stock traded at $0.5 apiece, you could buy 1000 shares for just $500. If the company’s worth increases, to, say, $2 per share, you would have earned a $1500 profit on your investment. And if the stock collapses, you’ve only lost $500.

Very Big Risk

Have you heard the saying “bigger the risk, bigger the reward”? There’s nothing else that can describe penny stocks more perfectly. But perhaps we should add on to that phrase to include the fact that a big risk could also lead to a big failure to better encapsulate the situation here.

When it comes to penny stocks, they are often issued by very small businesses that could take years to turn over a profit. The worst-case scenario would be that they never do become profitable and may even become bankrupt. It is not uncommon for penny stock shareholders to see very little or no turnover from their investments at all.

It’s not easy to research such cases before investing either because penny stocks aren’t tracked by investment banks and mainstream analysts. Companies with less than $10 million in assets and fewer than 500 shareholders don’t even have to file financial statements with federal securities regulators!

Very Volatile

There aren’t many people who deal in penny stocks and the transactions are often quite small, which makes the trading market rife for exaggerated price fluctuations. This means that the stock prices could rise and fall so quickly that if you blink, you may miss it!

Penny stocks aren’t the best choice for the buy-and-hold investor. If you aren’t very tolerant of risk and acting fast, they may not be for you. You will need to keep a close eye on stock prices so you can sell when they hit a high point. Missing it could be the difference between a healthy profit and a miserable loss. But since the penny stock market isn’t too popular, you may have a hard time finding a buyer at the right time.

Penny Stock Frauds

The nature of penny stocks is that it is a niche market, it is not too regulated, and it’s unfamiliar to mainstream investors. This makes it an ideal playing ground for scammers to manipulate prices and promote sham businesses. For instance, perpetrators of a scam could trade stock back and forth amongst themselves to boost the price and then sell to unsuspecting investors at a high price. Such stock promoters often claim their company is on the verge of a big break and promise large rewards for minimal risk.