Penny Stocks 101: A Comprehensive Guide

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You’ve heard about penny stocks. The highs, the lows of investing in buying stocks under 5 and 1, but, you aren’t quite sure where to start. Grab a coffee and let’s go to school!

What exactly are penny stocks?

The SEC considers penny stocks to be small-capped stocks under the value of 5 dollars. While there are penny stocks that are traded on NASDAQ and the NYSE, most investors do trading through an individual broker.

Penny stocks are considered volatile by most investors. The gains and losses both can be dramatic. Thestreet.com likens penny stocks to “Wall Street’s Wild West” that is a far cry from the the glitz and glam of major stock trading on the NASDAQ and NYSE.

Unfortunately for penny stocks, they have gained a bad reputation for scams and corruption. When considering investing in the wild word of penny stocks, some good ole’ fashion research into the companies you are considering is necessary. Penny stocks are kind of like relationships: Never settle. Only invest in high-quality companies!

How do you buy penny stocks? 

Not all penny stocks are listed on the main exchanges of NASDAQ and NYSE. Regardless of whether your stock is listed with these two major heads, you will need to purchase your penny stocks through a normal stockbroker.

The benefit of purchasing only penny stocks that you find on NASDAQ and NYSE is that you are pretty much guaranteed to be scam-free. These exchanges have strict listing requirements which make the penny stocks within these two realms more reliable, albeit the potential gains are lessened due to the strict regulations.

Penny stocks are most often listed on the OTCBB and Pink Sheets which are lesser known listing services. 

The Over the Counter Bulletin Board (OTCBB) maintains listing requirements though they are less strict than the two main exchanges on Wall Street. OTCBB over Pink Sheets has more validity due to the listing requirements.

Pink Sheets is simply a quotation publisher; it lists the quotations of stocks that are registered with it. Pink Sheets is not listed with the SEC and has no listing requirements to speak of making Pink Sheet stocks more volatile.

What is the potential payoff of buying penny stocks? 

The very reason most people shy away from penny stocks is the same reason that there could be a potentially big pay-off with penny stocks: volatility.

While cases of stocks jumping from .11 to 11.00 are few and far between, this scenario does sometimes occur and that rare chance is enough for some to be willing to consider investing in the ups and downs of penny stocks. There have been instances where investors have gained 1000% in a couple weeks time by playing their cards right.

Do your research to find the right stock with the most potential to jump from a penny to a power stock. Having an experienced adviser in this process when you are first starting out is invaluable.

What are the risks of selecting penny stocks to invest in? 

There are two major risks of entering the penny stock world: low liquidity and poor reporting standards.

According to the SEC, “Penny stocks may trade infrequently, which means that it may be difficult to sell penny stock shares once you own them. Because it may be difficult to find quotations for certain penny stocks, they may be impossible to accurately price.”

To put it into layman’s terms, even if you do all the research possible, you may still end up with stock that is hard to get rid of and virtually worthless. Yes, the OTCBB does have listing regulations, but, companies who are delinquent with the requirements still appear in listings making it hard to know which stocks are good and which ones are potential scams.

To combat the possibility of investing in a delinquent stock, the SEC has added a legal requirement for your broker to send a detailed outline of inherent risks of penny stock ownership before you make your final purchase.

If you are buying penny stocks, here’s how to avoid penny stock scams.

Above all, avoid questionable e-mails! Add to that list sketchy message boards, chat rooms, advertisers, and discussion groups. You want your research to come from recognized, reputable platforms.

One of the main scams out there is the “Pump and dump” scam where unscrupulous people decide to buy up a load of worthless shares to then pump up as valuable stocks selling them at an extremely inflated price. You can avoid this by listening to your gut and experienced adviser on the matter.

Penny stocks are a roller coaster ride, but, armed with an experienced adviser and enough research you can navigate penny stocks in a sustainable way. 

You must be prepared to ride through the volatile highs and lows of penny stocks. Consider your investment for the long-term, only pulling out if that jackpot moment were to happen where the penny stock changes to power stock. Don’t become hopeless if your stock takes a dive, it’s the nature of the machine. Be patient and wait it out. Learn the rules of the game to the best of your ability and have fun!

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