What Are Penny Stocks, And Are They Worth It?

by Andrew McGuinness     Nov 05, 2020

Penny stocks are high-risk but potentially high-reward investments so dealing with them warrants greater care than investment in regular stocks. Penny stocks often appear scammy since they don’t appear on big-name trading markets like NASDSAQ. On the other hand, penny stocks are incredibly speculative in nature, which can give you amazing returns if you put your money in the right one.

What Makes A Stock A Penny Stock?

Just by looking at its name, you can already guess the defining trait of penny stocks. As opposed to regular stocks, penny stocks are, by definition, affordable stocks that can be bought for less than $1. This definition doesn’t ring accurately nowadays since there are stocks priced at $5 or less that are still considered a penny stock.

There’s a reason why penny stocks are the way they are. Companies listing their penny stocks are usually those that are destined for bankruptcy or are highly leveraged. Because of this, the stocks can go anywhere from $1 to $1.50 in a matter of hours, or reverse if you’re unlucky. Note that while they aren’t trading on the big market, they can be found on Pink Sheets and FINRA’s OTC Bulletin Board (OTCBB), although dealing with either should be done cautiously.

Are Penny Stocks Worth It?

You might be thinking, “If a stock costs less than a meal, then why am I even bothering with it?” To the unimaginative and skeptical, penny stocks might seem like a waste of time but investing in good ones can give you insane returns.

Think about it this way: say you invested in a penny stock called $XVR for $1. You bought $5,000 worth of stocks for $XVR. After one week, you check its market price again and see that it’s gone up from $1 to $2. In just a week, you double the price of your investment.

Of course, this isn’t always the case. If penny stocks were any easier to predict then a lot of people would be investing in it. Given the nature of these companies in the first place, you have to be extra critical when it comes to putting down your cash. But as the example proves, it’s not impossible to get great rewards out of this kind of stock.

How To Get The Most Out Of Your Penny Stock Investment

- Investigate company’s track record: As with regular stocks, penny stock companies are run with management that can make or break your own investment. One of the easiest ways to look into a penny stock is by studying the management and the company’s history.

- Know when to sell your stocks: As opposed to most assets, penny stocks aren’t meant for long-term holding. This entire market is designed on short-term trades, so make sure you know the right time to get out.

- Always watch liquidity and trading volumes: Short-term trading is the essence of penny stocks, which means the next best thing about your stock should be its liquidity. Having a liquid asset will allow you to trade more efficiently instead of having a lot of demand but no supply.

- Put a cap on your holdings: Overinvestment has always been the bane of many investors, and the same goes for penny stocks. You might be excited at the prospect of doubling your $20,000 capital overnight, but if you don’t watch out, this could easily lead to zero. Test the waters and minimize your losses by investing fair amount of capital into different stocks. As is the case with regular stocks, learn to diversify with penny stocks.

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