Penny stocks have a catchy name, but are they worth your investment? According to the U.S. Securities and Exchange Commission, a penny stock refers to a security issued by a very small company that typically trades at less than $5 per share.
A cautionary tale
The SEC reports that penny stocks are usually quoted on OTC Bulletin Board or Pink Sheets. However, they may also be traded on securities exchanges, domestic and foreign. In Forbes, financial advisor Jordan S. Terry writes, “Just because a penny stock is a small/micro-cap and/or development/transformation stage company doesn’t mean you can’t apply some of the same analytical techniques we use for larger companies to identify risks and determine if a given stock is worth your investment dollar.” Terry reminds readers of many warnings from the SEC about the risks of penny stocks. Penny stock companies tend to be new and do not have a proven, positive track record. The SEC also warns that some companies do not even have assets or operations. More often than not, a lot of products and services represented in penny stocks are still being developed or have not been thoroughly market-tested. It should also be noted that penny stocks are difficult to trade once they are owned because of associated risks and low trade value. The SEC considers penny stocks a speculative investment and cautions those interested that there is a real possibility you can lose your entire investment or more if the stocks are purchased at margin-level.
A few considerations
If the SEC and other financial experts haven’t scared you out of investing in penny stocks, here are a few tricks of the trade to keep in mind as you dive into this unpredictable investment arena:
- Financial advisors suggest investors think of penny stocks as a gamble and not a trusted investment. You could invest a few thousand dollars for 100,000 shares of a stock that could quickly disappear from a listing if the price drops low enough for the market. There is no such thing as a refund in the investment arena, so invest wisely and carefully.
- Although penny stocks are listed in the OTCBB, the requirements are not as demanding as the NASDAQ or NYSE. Fewer requirements tend to lead to less transparency, which only increases the risk that already exists with these types of stocks.
- Try not to put too much “stock” in penny stock success stories. Do your own research and do not trust just anyone who tries to convince you penny stocks aren’t as scary as they sound. Always remember that if something sounds too good to be true, especially in regards to money, it probably is.
- Some advisors recommend selling penny stocks quickly if you turn a sudden profit in just a few days. They are obviously easier to sell right behind a real-life success story. Other investors warn that penny stocks typically do not gain value over time so it is better to buy and sell in the same day to avoid the pitfalls of owning too many shares with very little value.
The general consensus among financial advisors seems to be to steer clear of penny stocks because there is simply too much risk involved. However, penny stocks are certainly a tempting investment because of the low upfront cost. Just be cautious and don’t invest too much too quickly. After all, there are plenty of reasons why penny stocks have gained such a poor reputation. The bad might outweigh the good in this case, but that doesn’t mean you can’t find success in penny stocks if you invest carefully and do proper research.
[box_light]John Gower is a writer for NerdWallet, a personal finance website dedicated to helping you save money with financial tips on everything from travel to high CD rates.[/box_light]