Penny Stocks: Understanding the Risks & Potential Rewards

Penny stocks, also known as pennies, are shares issued by small companies that trade under a dollar. In recent times, however, the Securities and Exchange Commission has expanded the meaning of the term to include stocks that are priced under $5 and are traded in the Pink Sheets, or the OTC Bulletin Board. The companies that issue these shares do not have the financial standing to meet the requirements of a regular stock exchange listing. Many people are lured into putting their money in penny shares because they are very inexpensive.

Affordable Investment

One of the main reasons why investors are attracted in pennies is due to their affordability. Anyone can own thousands of shares in a small company for a fraction of the cost of investing in stocks listed in regular stock exchanges. If you are interested in diversifying your investment portfolio, you can buy a significant share in a growing company for a small amount. At the same time, new investors can easily find companies that trade for as low as 10 cents. Due to the small investment needed, anyone can buy and trade pennies.

Good Profit Potential

Just because pennies do not require a huge investment does not mean that they have very low profit potential. These stocks may be cheap, but they can earn an investor huge amounts of profits.  Since you are investing in a small company, there is a large potential for growth. Some investors gain as much as 50 percent of their investment costs. In larger stocks, however, it is not very often that your investment will grow up to half of its acquisition price.

High Price Volatility

Pennies are volatile. Hence, if there is a high potential for profit, there is also a high risk of losing your money. Almost 95% of startup businesses close down within five years of operation. Many companies that issue pennies may be bankrupt in a few years. Also, these stocks have low trading volumes. You might not be able to immediately dispose of your penny investments quickly.

Lack of Information

The Securities and Exchange Commission regulates large companies and requires that they provide ample information to investors. On the other hand, many small companies usually do not have adequate historical and financial data that a potential investor can use to measure the financial strength and viability of the businesses. Lack of information opens the door for fraud.

Once you consider everything, penny stocks can still be a good addition to your investment portfolio. Just remember to choose a startup company that can provide you with all the financial data you need. Perform your due diligence study on a company and its products before you buy penny shares.