The Basic Risks Involved in Penny Stocks

If you are considering getting involved in trading penny stocks, you should take time to learn about the risks involved in this form investing. The problem is that most companies who issue this type of stock have very low market capitalization and as such tend to be highly volatile. Trying to pick the hottest stocks is very challenging and considered to be one of the most speculative forms of investing available.

Those who invest in the penny stock market typically invest in stocks that cost less than $1 but cannot cost any more than $5. With so many websites and online services out there trying to rope you into investing in penny stocks, you should be well aware of the risks involved in this form of investing before you spend any money.

Price Manipulation

The low volume of shares traded on a daily basis makes the market very easy to manipulate. One of the more common schemes is referred to as the “Pump and Dump.” The pumper sends out emails, letters, newsletters, or uses message boards to pump up or promote a particular penny stock and drive the price up. The moment the stock hits the pumper’s predetermined price point, they sell out and leave the other investors sitting on stock that is worth less than the investor paid for it.

Exchanges That Go Mostly Unregulated

This is another major issue with trading penny stocks via Pink Slips or Over-the-Counter as there are no regulations in place to protect the investor. This is an especially big issue for those trading in penny stocks as the lack of regulation can easily lead to any number of scams or market manipulation schemes.

The Lack of Financial Statements

Typically, when an investor hears about a hot stock, the first thing they do is take a look at the company’s financial statements. Being a successful investor requires you to understand income statements and the company balance sheets. The problem with penny stocks is that these companies rarely produce financial reports leaving you with little to no hard data to analyze, making it impossible for you to know what their current financial status looks like. This situation can make it very hard to determine how successful your investments are likely to be.

A Distinct Lack of Liquidity

While this may not be true of all penny stocks, a large percentage of them are not particularly liquid. Some companies are lucky to see between $10,000 and $50,000 exchanged on a daily basis. With such small amounts being traded, reaching “competitive prices” can be very hard to achieve, and selling positions for larger investors even more challenging.

As you can see, investing in penny stocks comes with a few risks, they are well-suited to traders who find themselves addicted to the potential for rapid profit. It is possible for a penny stock to increase in value by as much as 10 to 20% in a single day and the potential to increase by up to 100% within a couple of weeks. While it is possible for you to lose a lot of money, there are those who have mastered the art of trading in penny stocks and make a living doing so. Buying penny stocks may be high risk and may not be for everyone. However, it is a personal decision that must be made by the individual investor.

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