5 Penny Stock Investment Risks You Need To Know

Understanding Penny Stock Investing

Penny stocks are frequently touted as a surefire way to make a lot of money in a hurry. Penny stocks are defined as any stock with a price of under five dollars by the Securities and Exchange Commission (SEC). Is it possible that it's really a reliable way to trade your path to riches?

Most investors consider penny stocks to be those stocks that are traded on the over-the-counter bulletin board (OTCBB) or the pink sheets. So you can't find penny stocks on the New York Stock Exchange or the NASDAQ. What are the risk factors? Read to find out.

1Insufficiency Of Solid Information

One of the critical factors in being a successful investor is having good, reliable information. You also need enough facts and figures. Penny stocks that are on the pink sheets aren't filed with the Securities and Exchange Commission.

Hence, there is far less scrutiny on these companies. The available information often comes from unreliable sources. There really isn't a reliable method to obtain the information that you need unless you can get it directly from a reliable source at the company.

2Absence Of Historical Data

Many of these companies are newly formed. Some are on the verge of bankruptcy. Many of the companies have no track record at all.

Many of the others have a poor track record. Again, there is a lack of information. This makes it difficult to make an intelligent decision.

3No Minimum Standards Being Set

The stock exchanges that you're most familiar with, like the NYSE, have minimum standards. If those standards aren't maintained, the stock is delisted. Any stock can be listed on the pink sheets or the OTCBB.

The minimum standards do provide some level of safety to investors. The lack of it creates a lot of challenges for the typical investor. How will you know if the company is even legitimate or if it is merely just an entity to defraud investors?

4Inability To Be Liquid

Penny stocks are not nearly as liquid as regular stocks. You can't just decide to sell. Plus, you can't expect to unload your penny stocks instantly.

It's not always easy to find someone who is willing to buy at what you consider to be an attractive price. The price can change quickly with these stocks. Not being able to trade fast can cost an investor a lot of money.

5High Occurrence Of Fraud

Penny stocks are very frequently used as vehicles for fraudulent activity. It's very common for brokers to defraud investors. They do this by manipulating the price of penny stocks.

The lack of liquidity and relatively low trading volumes make it possible for brokers to artificially drive up the price and earn a profit on their own holdings. There are a variety of other schemes that commonly take place as well. The lack of regulation, low trading volume, and lack of information available to investors create many opportunities to take advantage of investors.

Penny stocks of reputable companies with good future prospects do exist. The biggest problem for the investor is getting enough information to find them. Without the right information, it's impossible to make well-informed decisions.

Thus, penny stocks are best left to those with an intimate knowledge of the company and industry in question. These are very high-risk investments that have a high opportunity for both loss and gain. As always, ensure that you do your research before you put your money at risk.

About Author

Jackie Wing

Jackie Wing is an Alaska native who enjoys snowboarding more than is probably socially acceptable. She lives in Anchorage with her two dogs Reese and Peanut or as she likes to call them Thing 1 and Thing 2.