Penny stocks are low-priced investments with the potential to turn a handsome profit. But they’re also risky, which means you could lose a load of cash if you invest in the wrong penny stock. So it’s worthwhile to understand how penny stocks worth before making an investment decision.
Read on to learn more.
How Penny Stocks Work
A penny stock “refers to a security issued by a very small company that trades at less than $5 per share,” according to the U.S. Securities and Exchange Commission (SEC). And instead of trading on an internationally recognized exchange, like the National Association of Securities Dealers Automated Quotation System (Nasdaq) or the New York Stock Exchange (NYSE), they trade on the over-the-counter (OTC) market.
Are There Fees to Trade Penny Stocks?
You should expect to pay brokerage fees on penny stock trades. While there are no set rates, they should be comparable to industry averages on trades involving regular shares.
What Return on Investment Should You Expect?
The potential return on investment on penny stocks is vague because of their volatility. Here’s what the SEC had to say:
Penny stocks may trade infrequently, which means that it may be difficult to sell penny stock shares once you own them. Moreover, because it may be difficult to find quotations for certain penny stocks, they may be difficult, or even impossible, to accurately price. For these, and other reasons, penny stocks are generally considered speculative investments.
Simply put, investing in penny stocks is a huge gamble because their trade activity isn’t nearly as frequent as what you’d find with other securities. As a result, you may find it practically impossible to get them off your hands, and if you do find a potential buyer, deciding on a price per share is another challenge because there’s very little data available.
So if you do decide to trade penny stocks, go in with an open mind and be flexible with your expectations in regards to the return on investment.
How to Trade Penny Stocks
Step 1: Research your options.
Are there penny stocks that you find intriguing? Before taking the leap and making a purchase, conduct research to learn more about the company. Look for trends that provide additional insight into the current price per share, along with indicators of how the company is poised to perform in the coming weeks, months, and years.
You can do the legwork on your own or solicit the assistance of a reputable penny stock trader. If you do the latter, be sure to use your judgment when making trades as some of the knowledge they share with you may not be objective.
Step 2: Determine the optimal investment amount.
The amount you choose to invest should not put you in a major financial bind in the event you sustain losses or break even. But if you have a nice sum of cash to play with and you have a good feeling about a particular stock, it may be worthwhile to buy shares.
Step 3: Start investing.
It’s relatively simple to start trading penny stocks. Word to the wise: smart small and work your way up the ladder. Once you’ve got a few trades under your belt, feel free to ramp up your trading volume as the opportunity arises and you see fit.
A Word of Caution
Unfortunately, the volatility of penny stocks isn’t the only major drawback you have to be concerned with. Many schemes are running that promise you a huge return on your investment.
But when you fork over your money, you get the shorter end of the stick because the shares are practically worthless or don’t exist. For these reasons, you want to do your research, as suggested earlier, to minimize the chances of falling victim to a fraudster.
Potential red flags for penny stock scams include:
- High-pressure sales tactics
- Over-inflated promises from brokers
- Spam emails inundated with claims that seem too good to be true
- Internet ads with superficial promises, like the guarantee of a four-figure return on investment when you buy shares by a set date
- Cold calls from fraudsters disguised as brokers with designations that they don’t have
Should You Invest In Penny Stocks?
If you’re new to stock investing, trading penny stocks may not be a wise move unless you can afford to take a loss. While you may turn a large profit, keep in mind that penny stocks are tied to small or micro-cap companies that may be riddled with issues that are deep beneath the surface. In turn, their shares are low and if you hold on for too long and things go left, you could lose your entire investment.
On the other hand, the low price per share could be tied to a temporary cash-flow issue. And if the company manages to get a large capital infusion from somewhere or experiences rapid growth as a result of an adjustment made to operations, the price per share could increase rapidly, earning you a handsome return.
So while the choice is ultimately yours, you have to determine if the potential reward is worth it compared to the risk you’ll need to take. And you must also consider your financial health; if you have the cash to play with, it may not be a big deal if you lose out. But if you’re on your last few dollars and are looking to strike it rich, penny stock trading is probably not for you.
Well, at least until you get back on your feet, you may want to refrain from investing in penny stocks. And you probably still won’t make a fortune anytime soon.
The Bottom Line
Penny stock trading can be risky and rewarding at the same time. It just depends on which company’s shares you decide to buy. But if you’re still on the fence, consider making a few mock or “paper trades” to get a feel for trading penny stocks before you put your hard-earned cash on the line.