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Penny Stocks and what is it about?

A penny saved is a penny earned, a penny stock invested in is…?

In trading, certain terms or ‘lingo’ may be quite challenging to understand, especially for beginners. Penny stock is not one of them. The definition of what penny stocks are is relatively easy. In very simple terms, penny stocks are cheap stocks, but not just cheap — they must fulfill certain criteria explained below.

What is it about?

What do penny stocks refer to? Penny stocks essentially refer to certain stocks whose prices are relatively lower than a certain threshold.

Penny stocks are simply stocks that don’t achieve a certain price to be deemed like the other stocks you often heard of.

Who decides this price? That would usually be the regulatory body of a certain country. In the US, for example, The Securities and Exchange Commission (SEC) has the say in this matter.

What is the maximum price of a penny stock?

For one stock to be in the penny stocks category, it must be below a certain price. However, the limit is different in each country. In the US, for example, the price is at $5 — so, if a stock moves above the $5 price, it ceases to become a penny stock.

In Indonesia, the price of a penny stock is below Rp. 1,000, which is around USD 0.064 (at the time this was written).

Thus, there is no streamlined system to determine what are considered as penny stocks, and the maximum price of penny stocks may differ by country. Some countries don’t just consider the stock price in the market as the determinant, they also look at other factors such as market capitalization and other things.

Can you buy penny stocks like any other stocks?

Some penny stocks are listed on large exchanges like Ambev S.A. (NYSE:ABEV), Itaú Unibanco Holding S.A. (NYSE:ITUB), and Summit Therapeutics Inc (NASDAQ:SMMT). For these ‘exceptional few’, you can buy the stocks just like you buy any other stocks from the same exchange.

However, in most cases, penny stocks don’t fulfill the requirements to be listed on an exchange, so they’re traded over the counter (OTC).

How does it work? OTC is a trading system where securities are traded via brokers or dealers, and not in the exchange. In the US, for example, penny stocks are usually traded via OTC Bulletin Board (a digital service provided by Financial Industry Regulatory Authority) or through OTC Markets Group (a privately owned company).

Are penny stocks a good investment?

When speaking of penny stocks, there are a lot of pros and cons to them but we try to keep it concise, so here goes –

Pros:
  1. High-returns

Investing in penny stocks is a hit-or-miss, but it is undeniable that when things go your way the returns are going to be mouth-watering.

The reason behind its prospect of high returns is that penny stocks are usually for companies that are just established, whereby they are at the very early stage of growth — and there’s so much room for it.

That is why you can see growth of up to 300%, 400%, or even 1000% in penny stocks. Again, remember one thing: it’s a hit-or-miss!

2. Low cost

The most attractive part of penny stocks is that you can make huge profits at a very low cost. Well, as the definition of penny stocks itself suggests, penny stocks are stocks that are traded at a relatively low price.

That’s why despite its risk and volatility, penny stocks still manage to attract investors who are keen on putting in less for more. For a price of less than $1 for a lot of penny stocks, who wouldn’t?

Cons:
  1. Low liquidity

One thing you must keep in mind is that just because your penny stocks hit a heavenly high growth, it does not mean that you can sell it for that price. The reason behind it is due to its low liquidity.

Why do penny stocks have low liquidity? The risky environment that it is in. The companies’ financial records are usually limited, and some companies might even be a tool for fraud, while investors must also take into account that these smaller companies are at a higher risk of facing bankruptcy.

Thus, from these risks, investors are a bit more cautious in buying penny stocks, apart from the fact that it is traded by OTC method and not in an exchange. This low liquidity issue also leads to a low trading volume.

2. Unpredictable

One thing about penny stocks is that these stocks are usually of a newly established company or those that are just about to grow. Thus, there are many things that are not available or limited to investors such as financial reports, insights, and proper knowledge of the company’s well-being.

This will make it difficult for investors to make an informed decision about whether to buy or sell this type of stock. Doing your research is very important in investing, but it’s quite challenging when you don’t have much to research with.

That is what keeps penny stocks in the high-risk high-return spectrum.

Is penny stock a scam?

Are penny stocks scams? The answer is no. It is a legitimate stock, but there are many cases of penny stocks being used for fraud and scams. There are many types of scams using penny stocks, such as:

Dump and dilute: This is where a company issues shares constantly without any legitimate reason other than to get a hold of your cash, not to run a legitimate business. For this method, the company would usually then consolidate the stocks (reduce the number of shares) to make the value of the stocks appear high.

Pump and dump: This is where a person or a group of people decides to buy a certain stock massively, thus creating a hike in the stock’s value which would attract unknowing investors who think the company is actually doing well. Once other investors start to follow suit, the people who initially bought it would then dump their shares for a profit.

Chop stocks: This is where stock brokers and promoters seek to gain massive profit. It is a situation where a stock (usually large and illiquid) is purchased at a lower-than-market price by the broker but is then ‘chopped’ into smaller pieces that will be sold to the general investors at market price. Interestingly, this tactic is somewhat legal, despite sounding unethical.

Bottom line

Investing in penny stocks may be highly profitable, but do note that it is akin to the wild-wild-west of the investment world. Some may gain tremendously while others may be scraped off of their possessions mercilessly. It is a good place to discover companies that can soar in due time, but it is also a place of uncertainties and risk. If you’re keen on trying penny stocks, our advice is to proceed with caution and knowledge.

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None of the material above or on our website is to be construed as a solicitation, recommendation or offer to buy or sell any security, financial product or instrument. Investors should carefully consider if the security and/or product is suitable for them in view of their entire investment portfolio. All investing involves risks, including the possible loss of money invested, and past performance does not guarantee future performance.

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