Anyone who has never traded before will certainly get enticed with investing in penny stocks. The opportunity of investing just a few bucks with a potential of making big profits is very attractive. While this is true, one must know that it’s also possible to lose money in this kind of business. In fact, penny stocks are considered one of the high risk investments in the stock market.
If this is your first time to hear about penny stocks and would like to understand how they work, here is a guide about penny stocks for dummies.
What is a Penny Stock?
The term “penny stock” has various definitions, but generally, it’s a kind of stock investment that trades at a very low cost per share. The US Securities and Exchange Commission (SEC) consider penny stocks to be anything under $5 per share.
Because of the relatively low amount of acceptable investment, a lot of new investors are getting allured about this type of investment. If the trade works out, there is a potential of gaining high returns. For instance, you buy 5,000 shares of a $0.50 for $2500. If the stock reaches $2, you will be making $7500, tripling the amount of money you invested. And you can even multiply your earnings if the trade works well.
But here’s the thing: Penny stocks are considered highly speculative because they have lack of valuable information and poor liquidity, making them an easy target for fraud. As a new trader, you have to know first the process behind penny stocks before you put in your money in this type of investment. Sure, it is possible to make a huge profit in penny stocks – but only if you know how to play the game well. If not, there’s a high chance of losing all the money you’ve invested.
Read on to know more about how penny stocks for dummies work.
How Penny Stocks Work?
Penny stocks are mostly traded on over-the-counter markets, like Over-the-Counter Bulletin Boards (OTCBB) and Pink Sheets. Sometimes, they are also traded on major exchanges, like NASDAQ. But since NASDAQ has strict regulations, you won’t find a lot of penny stocks trading there.
Like any other stocks, you can purchase penny stocks through your broker-dealer. Your broker arranges the trade for you, and usually he or she receives a commission for this service. Your broker places your order and sends it to the trading room, where it is executed and your shares are bought according to your “bid” price.
Penny stocks can be played short-term or long-term. If you want to gain more profits, you can choose to keep your capital invested for years in a company, hoping that this will grow over many years. But if you only want quick gain, you always have the option to stop and place no more orders.
Profitability and Risk
The amount of gain varies in the penny stock world, but with the right timing, penny stocks can turn hundreds of dollars into thousands. 100%, 500%, or even 1000% returns are possible with penny stocks. And it is more tempting because there’s a potential of gaining profits in just a short period of time. In fact, lots of investors out there have success stories to share, saying that they were able to double their money just over night.
But although it is easy to make quick cash in penny stocks, there is also a risk to lose everything you’ve put in just as quickly. Sometimes, penny stocks are issued by companies that are in financial distress, using this as a way to save their capital and avoid bankruptcy. But although this is not often the case, penny stocks are still considered risky since they are mostly offered by small companies with little track record.
Furthermore, penny stocks are vulnerable to scams and manipulation. One of the most common fraud schemes in penny stocks is the “pump and dump,” where manipulators make false recommendations to rob a huge amount of money from unwitting investors. The increase usage of modern technology has made this kind of act much easier to perpetrate.
Even though there are many risks associated with penny stocks, a lot of people still insist on trading their money. It is true that every investment includes risk. It’s up to us how we handle and deal with those risks. Overall, penny stocks are a good thing, but you have to do your homework first and make further research before you invest any amount of money.
I hope this penny stocks for dummies guide helped you in some way.