There is no doubt if you pick a successful penny stock there is the potential to make a significant gain especially if it has been overlooked by other investors. In the USA a penny stock is deemed to be one trading for less than five dollars a share and they are often traded via the pink sheets and the OTCBB. By definition penny stocks are often illiquid and there are a number of factors to take into consideration if you are looking down this particular avenue.
Liquidity
As we touched on above, liquidity can be a major problem with penny stocks especially if there is something going on with the company. This may be good news or bad news, but it can have a significant impact upon your ability to both buy and sell shares in any real size. If there is good news and the share price is pushing ahead then you may find it difficult to buy in any decent size. While if there is disappointing news, with the share price heading south, you may find it difficult to sell in any size.
As a consequence, if you are investing in penny stocks this should be with money which you do not require in the short to medium term. There will obviously be occasions where unexpected financial demands mean you have to liquidate your assets but just bear in mind you may not get the market price for a sizeable stake. Indeed, unless there are ready buyers around you may find it difficult to sell a sizeable stake at all.
The spread
The spread between the buy and selling price of any stock needs to be taken into consideration when investing. Very often the spread in penny stocks can be significant and you could be in excess of 10% on the wrong side without any price movement. The spread of individual penny stocks will be determined by the liquidity and the size of the company. Many people forget to take into account the spread which very often means they need a significant rise just to break even.
That said, if you do your research and find a gem in the penny stocks market it can move fairly quickly when demand picks up. This is probably the best time to bank a profit on penny stocks because there will be buyers before the stock hits a short-term high. However, once a penny stock has started to turn down it can be difficult to deal.
Lack of information
The lack of information available about many penny stocks can be a plus and a negative. You will very often need to dig deep to find any information which may assist in your decision whether to invest or not. These types of stocks often receive limited coverage from any analysts and can sometimes be at the beck and call of speculators and rumourmongers. However, investing in penny stocks may be risky but if you pick the right stock it could be the next big thing of tomorrow.
Do not forget that many of the larger companies we take for granted today started out as penny stocks before they hit the big time.