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Should You Invest In Penny Stocks?

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Should You Invest In Penny Stocks?

The traditional notion of investing in stocks involves using a broker and putting your money in well-known companies that are classified as blue chip stocks. However, in the last few years or so, investing in penny stocks has taken America by storm. They are now more popular than ever, but should you invest in them?

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Penny stocks are quite literally that, and they are shares of stock that you can buy for pennies. Normally these are shares of stock in small companies that are publicly owned. The exact definition of penny stocks is unclear. Some consider them to be shares that cost less than $1, but some institutions consider shares that cost less than $5 tp be penny stocks. At this level, it can be hard to spot penny stocks because normally these are shares in companies that have low market capitalization; thus they need your investment. They also do not appear in the major stock exchanges. Instead they are traded via over the counter methods and on some institutions such as NASDAQ. At $5 per share, you can actually find shares that belong to high capitalization companies that are publicly traded in the main stock exchanges.

Why are people attracted to investing in penny stocks?

To most people, investing in penny stocks seems like a bargain. Because they cost so little, you can buy up a lot of shares for a meager amount. This would in contrast to buying shares in blue chip companies, which cost hundreds, and maybe even thousands of dollars for a single share. This is an attractive option to small time investors who do not have that much cash to invest in stocks.

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Penny stocks are highly speculative. You really don’t know how the company will perform because it’s often a small or newly established company. That means that buying and selling shares of stock can increase or decrease the stock price significantly. Massive purchases of stocks can quickly drive the price up. That can equate to massive returns for the investor. For example a $300 per share in a blue chip company needs to gain another $300 to double your investment. A penny stock that you bought for 50 cents only needs to reach $1 before your investment in doubled.

Many start-up companies trade over the counter at Pink Slips or the OTC Bulletin Board, which lend them some credibility and allow them to gain investors. If you are diligent enough to research these companies, you might be able to pick out promising start-ups and invest in them before they grow. What if one of them is the next Google or Apple?

The dangers of investing in penny stocks

Investing in penny stocks can be a high risk endeavor. Since these stocks do not appear in the big stock exchanges, there is minimal regulation and oversight on these stocks. With penny stocks, you do not have real reporting and disclosure standards established in trading over the counter.

Since these are small companies, most of the time they are not liquid at all. They only have a small capitalization structure, and they actually need your money to grow. However, they do not have a proven track record. You don’t really know if these companies will be able to make a profit. Many penny stock companies fold and leave you with nothing if you are not able to quickly get out.

Because of the limited regulation, it is easy for fraud to occur. Normally penny stocks tips are available in newsletters and various websites, but what you don’t know is that these are run by people who buy stock, and they push them by telling you to invest. Once you and other investors buy them, the price will increase and these people will sell them, making huge amounts of money.

The final verdict

Penny stocks can be a good way to start learning about investing, but you should only commit a small percentage of your portfolio. Probably devote no more than 10% of your portfolio to penny stock investing and do your due diligence. Research these companies and subscribe to stock tips that reputable financial publications consider as legitimate.

Only invest in penny stocks if you have the time to constantly monitor them because they fluctuate wildly. These are very short term trades, and you can probably buy and sell them within a day. And the most important lesson is don’t be greedy. You do not want to target too high of a return. If a share you bought at 20 cent show a current value of 24 cents, that’s already a 20% gain. Your best bet is to sell that and don’t speculate whether or not it will reach 30 cents.

Have you invested in penny stocks? Do you currently have penny stocks? Tell us about your experiences!

Investing Money

AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

18 Comments

  1. I made money in penny stocks. I have lost too. Lately I am only buying penny stocks that I can relate to. STVF for one. It’s a sugar substitute. If this takes off I will own a really really really big bike. 🙂

    • Haha. It sounds like you’re investing in all sorts of ways Jai. Penny Stocks are tempting, especially if you can find one that has solid financials.

  2. Penny stocks certainly aren’t for everyone, but since most of the traditional investing class avoids them, you can find a lot of good companies that just happen to be in bad company.

    Personally, I don’t care if a company has a share price of under $5. I do care if they’re listed on the Pink Sheets, though – since I think there’s some value in the SEC regulation on the major stock markets.

    At any rate, there’s one thing that’s certain: investing in penny stocks is WAY more fun.

    • Penny stocks are fun, but the bid/ask prices can get ridiculous. Also a lot of time the volatility isn’t there to get out a trade fast enough.

  3. I never have, but it sounds like these types of stocks are for the seasoned investor. It would be hard for newbies to keep an eye on them and know when to get out if necessary. I think when I start investing I’ll steer clear of them until I become more knowledgeable.

    • They are definitely for the seasoned investor.. or someone who wants to play around and get used to trading.

  4. I don’t invest in any individual stocks and especially not penny stocks. I had a friend who invested in some in college and made a few hundred dollars but he also lost money too. Having them go up or down a penny was a huge percentage swing! I couldn’t handle it that’s for sure.

    • Looks like you nailed it, for the long term investor or the person looking to buy and hold, this isn’t a good strategy at all.

  5. I don’t have any penny stocks at present. However, I am interested to invest in it. It will be just like riding bike on reverse gear because I am a trader and invested in big companies. I don’t have experience of trading with small companies so just want to try.

  6. Shawn the best thing about the penny stock bike ride is that with 50 bucks you can pay the game.. no need for big bucks to pay penny stocks.

  7. Dominique, I think the biggest advantage of penny stocks is “We can start it only with 50 bucks.” Therefore, it is first choice of most of the small traders however not bad for big bee in trading market.

  8. Plenty of experience with penny stocks. Make sure to use limit orders and not market orders, and also have an exit plan. I set my limit sell orders to cover my initial investment. Penny stocks are actually ideal for someone wanting to get a feel for day trading. But, yea, it’s not for everyone!

    • Good point Anthony. It’s definitely a market that you could lose your shirt in, so I think your limit orders are definitely wise.

    • Hi Keith. I actually don’t purchase penny stocks at this point – too risky.


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