There are certainly many appeals to trading penny stocks. With stocks regularly available at less than one dollar a share, you can accumulate far more stocks with only a minimal amount of capital.
For example, if you spend $100 on a penny stock priced at $0.25, you’ll be able to accumulate a total of four hundred shares. And if that stock jumps in price to just $0.35, your $100 investment is now worth $140.
Not bad at all, and if you have even more money to invest than a hundred dollars and buy a stock priced under $0.25 each, it’s very easy to see how trading penny stocks can make you a large amount of money in a short amount of time.
At the same time though, investing in penny stocks is not exactly risk free. On the contrary, it’s actually quite risky.
This isn’t to dissuade you from investing in penny stocks, but it is to tell you that you need to be careful about where you put your money.
Here are the top risks that come with trading penny stocks:
It’s More Difficult To Sell Than It Is To Buy
Buying penny stocks at the right price is easy. It’s selling it at the right price that’s more difficult.
This is because penny stock trading is almost totally reliant on speculation. In contrast to this, the shares of a normal stock are bought and sold based on the actual value of the company.
Let’s say that you buy a penny stock at $.10 and it jumps in price to $0.25. That’s a huge rate of return, and it would undoubtedly be a good time to sell because you’ve made monstrous profits.
But at the same time, if the price of that stock is now expected to fall, there may not be anyone who wants to buy the stock at that high of a price. It ultimately comes down to whether or not there are enough buyers willing to purchase your shares at a high price.
Pump and Dump Schemes Are Real
Pump and dump schemes are a serious risk when it comes to penny stock investing.
A pump and dump is when the price of a stock is inflated, either by a single investor purchasing huge amounts of the stock at a low price or the company of the stock being hyped up to invest (or a combination of the two).
The original investor then quickly sells all of their shares, which causes the prices to dip and for more investors to sell their shares as well, eventually causing the price of the stock to fall back to where it was originally if not below.
What this means is that if you see the price of a stock rising quickly, don’t get on the bandwagon for fear of missing out. The best time to buy a stock is when the price is very low with indications on the charts that it will go up soon.
Penny Stock Companies Are Riskier Investments
Finally, the companies of penny stocks are almost always smaller and less proven companies, and as a result are a naturally riskier investment. Often times these companies have low demand for their products and services on the market or may be in large amounts of debt.
You can mitigate this risk by choosing companies that are featured on the major exchanges such as the NYSE and the NASDAQ, but still, just know that you’re mostly investing in companies that haven’t exactly proven their mettle yet.
The Risks of Penny Stock Trading
Penny stock trading is going to be risky no matter what, and it’s important to be aware of those risks like we have just gone over before you invest a single cent.
The good news is you can make less risky investments by investing in the companies of penny stocks that have very strong fundamentals and a bright future (this is why thorough research of any company you invest in is key).
The best penny stock companies to invest in are ones that:
- Have real assets
- Have products and/or services that are in high demand
- Have strong market liquidity
- Have a strong business plan or white paper
- Have limited debt
Investing in the companies of stocks with those kinds of fundamentals does not mean that you are making a risk free investment, but it does mean that your level of risk will be much lower than it would have been otherwise.