I am new to the idea of stock market and stock exchange and I was thinking that penny stocks were more for beginners. However, while reading other posts and comments, I have been getting the notion that penny stocks are highly risky and not really a good idea. So, what exactly are penny stocks and how do they work? Is it as risky as some make it out to be?
Penny stocks are generally small companies (Small-cap) trading off the major exchanges. There are many reputable businesses trying to make a living so to speak in these minor leagues, but unfortunately they've earned a bad reputation from pump and dump scams over the past decade or two. They can be highly volatile because of the wide margin between the buying price and the selling price. With low volume you could be stuck hanging onto a penny stock for sometime unlike major stocks that are purchased and sold a dozen times over with the blink of an eye. It's likely much harder to do your homework on a penny stock as well. This Frink Enterprises company claims to be on the verge of completing a device that converts a babys cries into plain English but all you can find is one website claiming Frink is the genius of the century. His company financials are no where to be found, all you have is an address which appears to be a mini-storage unit. He very well could be the Thomas Edison of our times. But he could also be a crackpot with a gambling addiction. Meanwhile you can hop over to the NASDAQ pull up CSCO and find orders are up 28% for the coming 2nd quarter and the new CIO has found a way to reduce expenses by 9% by restructuring their short-term debt into long-term. If your new to the world of investing pick out companies you know and can follow easily. Yes there will be a myriad of different advice sites saying CSCO is on the verge of a major breakthrough or conversely CSCO is destined to become the next ENE, but unlike a penny stock you have all the info you need at your fingertips to decide for yourself.
There's a hell of a lot less transparency with penny stocks than you get with larger cap names that are more efficiently covered by brokers. Because of the inefficiency of this market you are more likely to be taking a speculative gamble rather than making an investment. I would always suggest to those new to investing to go with more liquid names that they are familiar with. The only reason that a lot of first-time investors go into penny stocks is the fact that they are in principle "pennies" and because they promise huge upside. Neither of these should be reasons for jumping into them.
The few times I've dibbled into penny stocks I got burned, even though I did my homework. It was just play money really but still, I know that it isn't for me. The lack of real transparency, like Onionman says, it part of the problem. The inherent risk is just too high for me so I don't bother with them any longer. In fact, I feel like many of them are ripe with dishonesty and fraud.
Sorry to bring this topic back again but I didn't want to use more forum space to ask this question and thought here would be best; With penny stocks, would you need to invest a lot to see some sort of profit if the stock started to rise?
well profit is always measured in %. Penny stocks, being more risky and volatile, can see some major up days and higher % than the more big and stable companies are the norm. That also works the other way around. So in that regard, you could see similar profits with a smaller amount invested but as always: higher profits come at a higher risk.
Only dabble very lightly in them, if at all. Most small retail novice investors probably shouldn't go anywhere near the very low-priced stocks - particularly if your money is limited. If you don't have a whole lot of money, you don't want to be wasting money on highly speculative stuff that is very, very risky - you want to make every dollar you invest count by investing in high quality investments. If you've got $100k or more in your account and know what to look for in a low-priced stock that is likely to make it a better than average "penny stock" pick, perhaps you can have $100 or so (not much more IMO) to fool around with on a handful of these at any given time. If you've only got $10k in your account, I'd say you'd probably not want to fool with much more than $10 or so worth of a few shares each of a handful of "penny stocks" at any given time. Always ask yourself before buying how it would impact you overall if the investment became completely worthless.
Many thanks for your advice and words JR Ewing. What I'm getting from what you guys are saying is that penny stocks could only be a worth-while investment if you have some insider info, otherwise it's a total gamble unless you know what your doing. Is that about right, or am I reading wrong?
Well, I wouldn't say "insider info" is needed. But you'll want to have SOME info from reputable sources available. You'd want to look for unique and innovative products or services, a fair amount of trading volume on an exchange such as NASDAQ (avoid over-the-counter stocks), and at least a little institutional ownership. I'd personally want to see some good sales and very strong recent sales growth if other fundamentals are lacking (such as actual earnings). If you see that a low-priced stock has very strong institutional interest, you can perhaps buy more of it than you would otherwise. Perhaps up to $100 worth of such a company trading below $1 a share in a $10k brokerage account IF there is such interest with very strong revenue growth.
