Those high prices may tempt you to seek out a bargain.
Penny stocks seem like an opportunity to buy into an up-and-coming company for dirt cheap.
At penny stock prices, you might afford to buy hundreds or even thousands of shares.
But watch out: Trading penny stocks could easily leave you broke.
Heres why its so easy to lose money buying penny stocks.
What Is a Penny Stock?
Most investors, though, take a narrower definition.
Many define it as one that trades for under $1.
The low share price isnt the only thing that defines a penny stock.
But most investors dont consider these to be penny stocks.
Penny stocks generally trade on the over-the-counter (OTC) market.
The transaction takes place between the broker-dealers for the buyer and seller.
They use the OTC market to name their prices.
Theres no central exchange facilitating the trade, which can happen without anyone else knowing the transaction price.
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The transaction may feel the same as it does when youinvest in stockslisted on a major exchange.
you might typically use whateverbrokerage accountyou normally use to trade stocks.
You place the order in the same way you would for any other stock.
Risks of Investing in Penny Stocks
Ever ask yourself Are penny stocks worth it?
The answer should almost always be a resounding, NO!
Heres why penny stock is among the riskiest investments you’ve got the option to make.
The information is publicly available atSEC.gov.
That company may not have to file with the SEC at all.
A company with under $10 million in assets is unlikely to draw much focus.
Companies traded on over-the-counter exchanges are subject to far less oversight than companies on a big stock exchange.
Companies listed on the pink sheets arent required to disclose much information.
Few Minimum Listing Requirements
Any stock that trades on major exchanges is subject to strict requirements.
Maybe they have no proven track record.
Penny stocks are often issued by companies that have never earned a profit.
Or maybe they do have a track record, but its a troubled one.
Then, youll see it on the OTC markets.
High Volatility
Penny stocks are a highly speculative investment.
A single piece of good or bad news can make or break your investment in a penny stock.
A relatively small change in demand for the stock can also result in major gains or losses.
But remember: Its incredibly difficult to find good penny stocks because theyre issued by unproven or struggling companies.
Low Liquidity
Most penny stocks have a low trading volume.
That means they trade infrequently, which is bad news for you when you want to sell.
Lets say you owned 5,000 shares of a company, but the trading volume is only 1,000 per day.
Youd realistically have to wait five days to sell all your shares.
Even then, you may have to sell for much lower than your ask price.
Rife With Fraud
The world of penny stocks is filled with fraudsters who prey on inexperienced investors.
Two of the most common penny stock scams are the pump and dump and the short and distort.
Scammers drum up hype about a company to drive up share prices.
Then they offload their inflated shares on unsuspecting investors.
Investors use a maneuver called short selling when theyre betting a stocks value will drop or become worthless.
When you short a stock, you essentially borrow shares in hopes that the price will drop.
Then it’s possible for you to buy it back at a lower price to close out your position.
With the short-and-distort scam, fraudsters short the stock, then spread false negative rumors about the company.
When share prices plummet, they profit.
We hope weve convinced you that buying penny stocks isnt worth the risk.
Youre much more likely to profit by investing in anETFormutual fundthat represents the entire stock market.
Dont invest it in penny stocks if the answer is no.
Your odds of losing money are substantially higher than your chances of profiting big time.
Also, double-check you understand the basics of the industry and how the company makes money.
A little knowledge will help you see through overhyped claims pushed by penny stock promoters.
To mitigate the risk, look for stocks with a market cap on the higher end of that spectrum.
But remember: The low liquidity can make it tough to sell penny stocks.
Thats 10% for ALL the risky investments.
Its essential to keep the other 90% in adiversified portfoliothats invested across the stock and bond markets.
Many mainstream brokerages andinvestment appsallow for fractional investing.
The bottom line: Be aware of all the risks before investing in penny stocks or anything else.
If you cant afford to lose money, penny stocks are best avoided.
For example, they are common targets for fraud.
This lets you start investing in any stock you want without necessarily investing a huge amount of money.
In theory, sure almost anything can make you rich.
A better question might be, are penny stocks a good way to get rich?
The answer tothatquestion is a definite no.
If you want to start investing on a budget, fractional shares are a much better bet.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder.
Send your tricky money questions to[email protected]or chat with her inThe Penny Hoarder Community.
Penny Hoarder contributor Dave Schafer updated this report.
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