Are Penny Stocks Risky?
Penny stocks are stocks in small cap companies that trade outside the major exchanges like NYSE or NASDAQ. They are traded over the counter and are also called OTC or micro cap stocks.
penny stocks listing fall into the high risk category of investments because of the many risks involved with them. These include limited liquidity, lack of financial reporting, ease of manipulation and fraud. Many of the spam emails people receive talk about these stocks as a sure fire investment with guaranteed overnight returns. This is not true; in reality investing in these stocks requires very careful planning and dedicated research. The various risks involved are outlined below.
Incomplete information available to the public. Information related to micro cap stocks is always more difficult to find. This is because the penny stocks are for companies that are listed on pink sheets. This means they are not required to file with the Securities and Exchange Commission (SEC). They are not open to the public for scrutiny and are not regulated. It is also very difficult to verify the credibility of these stocks.
Lack of a record of past performance. For any stock investment, it is imperative to check on the past performance of the stock. But in the case of small or micro cap stocks, the history available is almost negligible. This is because they are generally offered by companies approaching bankruptcy or which are new to the market. Thus, there is a huge risk in investing in a stock that has no credible history.
Liquidity. Penny stocks do not deal with ranking stock markets. Instead they are traded over the counter and are thus referred to as OTC investments. Dealing does not happen frequently so if a need arises to dispose of the stocks, it is difficult to find buyers for them. If you cannot sell the stock you are left with little choice other than to lower the prices until you find a suitable buyer. A low liquidity level also gives traders a chance to manipulate stock prices.
No minimum standards. Stocks listed on the pink sheet and the OTCBB do not have to fulfill certain standard minimum requirements to remain on the exchange. This is a deterrent for many investors who deliberately look out for the minimum standards that act as a safety cushion and a benchmark.
However,good penny stocks can give very good returns in the long run if careful research and planning has been done before buying them. They can be very profitable if you know what you are doing and you know enough to avoid the pitfalls. Consulting an expert in the trade before making a decision is advisable. You will also find many tools and services offered for traders of these stocks that help you get the maximum benefit out of your investment.
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