What is a penny stock?

Penny Stocks

 Talking in terms of the stock market, you might have heard of the term “penny stocks.” The definition can add confusion because not all penny stocks are bought at just a penny. Some refer to this type of stock to be under $5, and some refer to a penny stock as a stock that is not traded on one of the major stock exchanges such as the NYSE, Nasdaq, and AMEX, and instead traded with pink sheets or OTCBB (over-the-counter bulletin board).

Let’s back up a little and take a look at what a “stock” actually is. According to one of the most well-known stock market resources online, Investopedia.com, a stock, or also known as a “share” or “equity” is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings. The amount of ownership is a matter of how many shares one has purchased for ownership from that corporation.

There are two types of stocks:

  • Common stocks
  • Preferred stocks

Common stocks allow one to vote at shareholders’ meetings and receive dividends (earnings).

Preferred stock owners usually do not have the right to vote at meetings, however, they will have a higher claim on assets and earnings.

Most of the time, the biggest deciding factor on what stock to invest in or how many shares to purchase will greatly depend on the price of the stock; which varies day by day depending on how many people are selling or trading their share in a particular corporation.

What determines the buying and selling of stocks?

Speculation, most of the time, will determine whether an investor will keep their share, purchase more shares, sell, or trade which indirectly determines the price. Those who track their shares on a regular basis will determine how to go about managing their shares through speculating price in the future in order to make a “gain” or profit so to speak.

Since speculation is one of the biggest factors for investors in the stock market, it’s also one of the very same reasons many people choose to invest in penny stocks.

Investing in Penny Stocks

Investing in the stock market or any security such as treasures, bonds, etc. have risks factors. Penny stocks are known to be a high-risk investment which means there’s a high chance that one’s investment versus return has greater uncertainty than most other stocks, bonds, and securities. Many people compare high-risk investments much to a game of gambling because some investors come out way ahead, and some not ahead at all.

 

What makes penny stocks so risky?

  1. Not seen on major stock exchanges. Unlike stocks on the major stock exchange, penny stocks are for small to medium size companies. These particular companies that issue stock do not have the same strict requirements that are monitored by the government agencies. Just as any company that is not being monitored by the government, there’s less accountability being held to and a greater chance of failure.
  1. Traded Over-the-counter.  This typically means that the stocks are unlisted which trade over-the-counter bulletin board or with “pink sheets”. One of the reasons for a company to be listed on the OCTBB is usually due to bad credit scores and unless you know their history off-hand, the risk speaks for itself.
  1. Infrequent trade. Trading stocks has a history of advantages and unfortunately, penny stocks do not trade as often as regular stocks. Thus, difficulty selling the shares after you own them almost forces you to keep them.
  1. Little information. As previously mentioned, many times penny stocks are OTCBB or pink sheet purchases. Not only are they listed on the OTCBB because the company might be close to bankruptcy, but another reason could potentially be because they are a start-up business. Without a track record it’s difficult to see the potential this company may have.
  1. Overall value. Bigger companies on the listed major stock exchanges tend to have more value for a couple different reasons. One being, there are a lot more investors and analysts tracking a corporation on a day to day basis versus a small start up company or one about to go bankrupt. For that reason, revenues are earnings will be more predictable.

How to Invest in Penny Stocks

There are four steps you’ll take when investing in penny stocks:

    • Calculate your risk factor
    • Talk with a broker
    • Research
    • Recommendations

 

Calculating your risk factor.

It’s never a good idea to invest in penny stocks in hopes of a “get rich quick” game plan. No matter how hot the penny stocks seem to be going, if you are on living paycheck to paycheck you may want to choose something that’s not as highly speculative and volatile. Many brokers do not recommend holding anymore than 10% of penny stocks in your portfolio. However, if you don’t have much to lose and enjoy the exciting chase, it’s not uncommon for penny stocks to have a 50-300% jump in one day.

Talk with a broker.

That’s what they are there for, daily. They study, track, analyze and inform potential investors. Whether you’re just starting out with investing or just considering the odds for penny stocks, a broker has background and first-hand knowledge of what’s at stake.

Research.

You can not ever have enough information at hand before making an investment whether big or small. There is tons of information on the internet on penny stocks. If you found a company you are willing to invest in, be sure to find their balance sheet and look for incoming and outgoing expenses. It’s federal law for you to be able to find this information.

Recommendations.

Ask around to the different brokerage firms for recommendations before you invest. Some of the best brokerage firms available are:

  • Scottrade
  • Merrill Lynch
  • Ameritrade
  • Optionshouse Review
  • TradeKing
  • Zecco

However your strategy in going about investing in penny stocks, just be sure you learn all of the risks associated with all investments. To add to the success, make sure to do your research, talk with brokers, and be looking for recommendations for that added bonus.

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