The Pros and Cons of Trading Penny Stocks
If a company is too small in size so as to be listed on NYSE or NASDAQ stock exchanges, it can be traded through the Bulletin Board or Pink Sheets electronic quotation systems. The equities so traded are known as “Penny Stocks”. These are also sometimes referred ss “microcap stocks”.
The term applies to companies which have low or micro market capitalizations. These companies are generally having market capitalization of less than $250 or $ 300 million. In some cases, market capitalization can be even below $ 50 million (such stocks referred as nanocap stocks). The penny stocks are traded at very low prices.
There is always a confusion amongst the minds of investors whether to invest in the penny stocks or not. There are always pros and cons of investing in penny stocks which every investor should be aware of. There is a possibility that these penny stocks might reap returns heftily but carries risk of losing money also. In this article, we will discuss the pros and cons of investing in penny stocks so you can really decide what’s best for you.
The Pros of investing in Penny Stocks
Possibility of a big gain
Investing in penny stocks is just like gambling in a casino. If you hit you get huge gains else you lose. In large cap or mid cap stocks, you can earn a decent return if the market is bullish. But the return in penny stocks is not proportional to market growth. You can multiply your wealth manifolds if penny stock in which you are invested gains.
Quicker returns in few days
Generally, when you invest in a large cap or mid cap, you will get returns over the next 1,2 or even 5 years span. Whereas you can see exponential growth from investing in penny stocks in a few days only and sometimes even in few hours.
Not all penny stocks are bad
A general public perception is that all penny stock companies have poor financials and poor performances. But this is not true in every case. There are some small companies which are though small but have good financials. You need to identify such stocks which can make big story in future.
The Cons of Investing in Penny Stocks
High risk involved in Penny Stocks
Trading in penny stocks is a highly risky affair. There is a high degree of volatility in penny stocks due to which makes these stocks highly risky. So, choose to invest in penny stocks only if you have a high-risk appetite.
Non-availability of accurate financial information
Every listed company on an exchange like TSX or the NYSE is mandated to submit annual financials to the exchanges. However, in many cases, small companies (penny stocks) are non-compliant. Thus, you are not having accurate reports of financial performances of these companies. Therefore, you will have to trade blindly in penny stocks which is purely a guess work.
High probability of scams
Penny stocks are frequently found to follow market manipulations and mal-practices such as pump and dump. Pump and Dump schemes are where the promoters of the company pump up the stock prices artificially and once the stock reaches a desired price, the promoters sell or dump it. Thus, the investors are left clueless and suffer heavy losses.
You must be beware while subscribing for penny stock newsletters as these might be a potential trap for readers promoting a buy in low quality stocks at inflated prices and then dumping prices of the stocks later leaving you empty-handed.
Low volume of trades
Penny stocks are not frequently traded on the exchanges. The buying and selling activities in these stocks is very less. Once, you are stuck in these stocks, it will be difficult selling these back and your hard money will be lost.
To sum up
This article is not meant to discourage readers for trading in penny stocks. But we simply advise you to weigh both pros and cons of penny stocks. A proper and informed decision should be made for making investment in any stock else it might result in heavy losses for investors.
About Author & Disclaimer:
The article is written by Naveen Goyal who is also co-founder of taxwink.com. He has a deep interest in analysis and research in stock markets. The author as well as Taxwink.com does not promote trading in penny stocks in any manner. Investors are advised to beware of high risk and losses involved in penny stocks. Taxwink shall not be responsible for any loss or damage caused to any person from the information contained in this article. Investments in stocks and mutual funds is a subject matter of individual decision.
