The allure of buying penny stocks and making a fortune is appealing, and it is frequently fed by compelling marketing. Stock purchases carry varying degrees of risk, and penny stocks are some of the riskiest. Most penny stocks may not endure the regulatory scrutiny that established more expensive stocks do. The bottom line for you as an investor is research your investments carefully.
The Lure of Penny Stocks
Penny stocks include a wide range of prices. The Securities and Exchange Commission considers any stock trading less than $5 per share to be a penny stock, while others apply the name to stocks trading under $1. If you are considering investing $100, then you are probably looking at stocks trading in the bottom range. Because many penny stocks are not subject to the same reporting requirements as larger companies, fact-finding is consequently more difficult. Getting accurate financial statements may be difficult, for example.
Many penny stocks have low daily trading volume. If the volume is low, you may have a problem when you buy and sell. When you place your order, your purchase may be sufficient to drive the price up, so you end up paying an inflated price. Then when you sell the stock, the additional shares you put into the market drive the price down. Stocks have two prices – the bid and ask. When you buy a stock you pay the ask price, but when you sell the stock you receive the bid price. With actively traded stocks, the spread between bid and ask is very small, but with thinly traded stocks, the spread can be quite large. You can easily lock in a loss if your spread is too large.
When you buy a penny stock – just as you would with any stock – you need to research the company carefully. Many penny stocks are cheap for a reason. If there are no profits and no sales, walk away from it. If the company is billed as a turnaround situation or the next Apple Computer, be sure there is real potential before you take a position. If there are several companies engaged in the same industry, be sure to buy only the best of the lot. Be sure to read the disclaimers – be certain you have a real opportunity, not just a blind gamble.
While you should read all you can, beware of promotions that promise a quick buck. Frequently, the pop is caused by people who are enticed into buying by the promotion. Those purchases drive the price up as promised, whereupon the investors in the know sell their stock and the price collapses. This “pump-and-dump” marketing will usually be accompanied by a mailer with a disclaimer written in very small print. Beware of any stock that a marketing firm has been hired to promote.
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