If you are a beginner and want to invest a small amount in stocks and look around where to invest, then you may be interested in knowing what are penny stocks.
In the world of investments, there are numerous types of stocks available. But, as a beginner choosing the right stock is always a tricky and overwhelming task. In most cases, a wrong decision ends up in a loss of huge capital. Penny stocks or cheap stocks are quite popular but risky ones, and before investing in them, a proper guide is important.
Many newbies who have a very low budget, often take a chance and invest in penny stocks after listening to various so-called experts. Some of them got cheated and lose their entire investment. When you are likely to invest in penny stocks, there are certain aspects, you should be checking. That’s why we have highlighted all the key points related to penny stock buying and precautions while choosing the right company.
After reading this article, you’ll have a deep and clear idea of
- What penny stocks are.
- Advantages of penny stocks.
- Disadvantages of penny stocks.
So, before making it monotonous, let’s get started with the article,
What are penny stocks?
Penny stocks are typically denoting those stocks which are available on the market at comparatively low pricing. Any company that enlists its shares in stock exchanges hopes for a higher share price. But, some companies keep their share prices at surprisingly cheap costs.
How cheap?
It is as low as $5 per share or even lower. Penny stocks are often considered risky and speculative because they have low liquidity, high volatility, and limited financial information. Penny stocks are also subject to fraud and manipulation, such as pump-and-dump schemes, where promoters artificially inflate the price of a stock and then sell it for a profit. We will go deeper into that matter next to the article.
Companies enlist their stocks to the market at a price according to many key points such as
- Their market capitalization.
- Growth of the company.
- Profit margin.
- How long they have been on the market?
- Their reputation.
And many more.
For many, penny stocks are a great way to start their investing journey but many investors think, they are nothing but scams and often cause a loss of their money.
Penny stocks are also known as,
Micro-cap stocks, Nano-cap stocks, or Small-cap stocks.
According to the company’s market capitalization, they are denoted by different names. Compared to other stocks, penny stocks are way cheaper, and some experts state that you can actually buy penny stocks at below $5 for each share. But, you can grab the shares far low than this too.
If you check the share prices of a company, listed on various stock exchanges, and if the company is quite reputed and on the market for a while, you will notice, the share prices are quite high.
As of now, one of the renowned electric car manufacturers is Tesla whose share is running at $214 per share. Amazon, which is the largest e-commerce platform, has its shares at $101 per share. Now, penny shares are way cheaper.
Penny stocks are not listed on stock exchanges as they are volatile and have a very low trust ratio. Now, one may ask,
Are penny stocks scams?
If you are wondering the same, you are not alone. There are many investors especially beginners because, where the shares of reputed companies are high, there are relatively cheap in cost. So, are they scams, or is there something that is not fair?
The answer is, not all the time. Looking at their cheap stock price, and zero to little financial history it is easy to assume penny stocks as frauds or spam, but many of them are actually legitimate businesses that are looking to grow their business. Many companies have great products and futuristic visions but due to some reasons, they are offering their stocks at this cheap price.
Below we are mentioning some reasons,
Why companies offer penny stocks.
It’s a new company:
In most cases, companies, which just listed their name, or just started their journey typically offer penny stocks. People tend to buy stocks of popular and old companies because, they are on the market for a long time, and they have trust in them. Investors are always hyperactive in buying shares of those companies.
But, that’s not the case with new companies. After all, they have just started. Very few people would dare to buy their shares which are not listed on the stock exchanges too. Now, if the company charges a high price for their shares, then chances are high, nobody will buy them.
Certain downfalls in business:
More or less every company faces downfalls in business and some companies can’t cope with it. A company is going through a downfall, and the financial state is not quite right offers its stocks at very cheap pricing so that, it can raise some funds. When a company is losing its market or getting, investors take their step back from them.
These are some reasons that drag companies to offer their share price at low prices. Now. it’s time to point out some benefits of investing in penny stocks.
Penny stocks benefit:
There are many benefits that grab the attention of many investors.
Meager investments:
For beginners or people who have less money to invest, penny stocks are always a great option to start. If a big and reputed company does not face any exceptional hardships, its share prices do not fall so big deep. If you are looking to buy their shares, you are going to pay quite a significant amount.
Penny stocks can be availed at very cheap pricing. If your budget is super tight, then what else can you go with?
Higher returns:
It’s true that many investors lose their money by investing money in penny stocks, but still, it is a great opportunity to gain higher returns if the stocks are genuine.
Not all penny stock companies vanished from the market or were just scams. Some of them stay in the market and perform well. So, the stocks are right, you have a better chance of receiving much higher profits than the amount invested.
Sudden high growth:
Most of the companies that offer penny stocks are actually new on the market. They just have started their journey. All positive key points such as taking the right decision, right management, and other things often take the company to the next level. In that scenario, the company gains lots of finance. Sometimes the company grows up overnight and so happens with the shareholders. With the other stocks, it usually takes longer to see some unbelievable growth.
But, as penny stock companies start from the grass root, they have a big chance of gaining overnight high prices.
As you have read the above portion, you have understood the only positive point about penny stocks is expectations of huge returns.
And only focusing on the positive points might not be a good idea. So, exploring all aspects is necessary.
So, here we are with the disadvantages of penny stocks,
Penny stocks disadvantages:
The most important reason would be,
High fraud risks:
For enlisting penny stocks, there are no strict or minimal compliance requirements. Hence, there is a high chance that the stocks are actually scams. Typically penny stocks are not available in reputed stock exchange markets such as NASDAQ, or the New York stock market.
When a company enrolls its shares to the reputed stock exchanges, chances are very low of any scam. But, as penny stocks do not fulfill compliance requirements of the stock exchange, they are not allowed to enlist their shares.
Lack of information available:
Before buying any share, people are willing to figure out all the information such as,
- The financial state of the company.
- Their business model.
- Their key position holders,
- And other vital information.
That gives an idea to determine the positive or negative growth of the company. But, companies that offer penny stocks do not disclose such information. Also, you cannot find the financial history that is really important. That makes them hard to predict. It increases the chance of investing your money into the wrong penny stocks.
Low liquidity:
Another big problem with penny stocks is they come from small companies that are not renowned. Companies such as Tesla, Tata, and Reliance are very popular companies around the globe. If you have their shares and want to sell them, the job might not be so difficult because they are very popular, and anyone with the intention will purchase their shares. But things are different from the penny stocks.
The companies offering those shares are not so popular. Even if you gain a smaller margin than the buy value, and you are looking to sell those shares, you might face problems. As the company is not very popular, you can face issues selling your shares.
These are some drawbacks of penny stocks. But, as there are many benefits too,
So, should you buy penny stocks?
Well, as you have read the article, you have already understood there is so much risk in it. You may lose your entire investment through penny stocks. Still, if you want to invest in penny stocks, you can follow the tips mentioned below to minimize the risk of facing any fraud.
Tips to find the right penny stocks:
Before you are willing to spend your investment on penny stocks, you should keep in mind these tips.
Research properly:
Even though there is very little information available out there, still, you need to check as far as you can. The more you dig, the chances are you won’t fall into a trap. You may get information and the authenticity of the penny stock through social media posts, unsolicited emails, or and online forums. There they may claim that they have core information about the company and that you should buy their stocks.
But, that is something you should avoid. Instead, it’s better to use your own resources and diligence to verify their claims. You can follow the company’s press releases, SEC filing, and more documents. before you buy the stocks of that company. Look at their management team, their product or service, and their competitive edge. If your research shows that the information is vague or something unmatched with their claims, it’s better to refrain from them.
Don’t go for paid advice:
As there is very little information available on that particular company that is offering the penny stocks, many experts will claim to have information about it and they would offer to share it with you in exchange for money. Most of the time, they are also frauds. They might ask you if, they have the inside information, and you should invest in them, but it’s not a good idea at all.
Look eye on the hype and fake promises:
Many companies that are not fair, sometimes, try to create false hype amongst people. They claim to give impressive returns on investments. To support their statements, you may find testimonials of many people on their website, and many popular social media influencers may promote them too. But, just because social media influencers are promoting them it does not mean they are legitimate. So, be skeptical of the hype. They also, try to attach you emotionally and make you believe that their stock prices are going to skyrocket but, decision should be made after thorough and genuine research.
Buy from reputed exchanges:
As most of the penny stocks do not comply with the reputed stock exchange’s policies, they are sold from outside.
But, still, there are plenty of stocks on those exchanges such as NASDAQ or NYSE. You can buy cheap stocks from there. The chances are quite minimal to invest in penny stocks compared to outside.
Decide how much can you lose:
Before you buy penny stocks, decide how much of your capital you can lose. Even if you have a little capital, you should not invest everything you have. Only invest that amount, and you can bear the losses.
As investors get the shares at unbelievable prices, there are many risk factors. Penny stocks are typically very volatile. In the worst-case scenario, you can end up losing all the money you have invested in the penny stocks.
Conclusion:
There are very strong reasons to avoid investing in penny stocks but still, we cannot ignore some incidents where penny stock buyers become huge gainers in the long run. So, our advice is, if you have some money that you afford to lose, then you can invest that money in penny stocks after thorough research. Who knows, you might be a big gainer in the future for those stocks!
Thanks for reading. Explore more related articles.
- Share Price Fluctuation: These Are The Reasons Behind It.
- How To Invest In The Share Market? Excellent Tips For Beginners.
- What Is Intraday Trading? Don’t Get Into Before Reading It.
