Penny stocks have made me ill for the most part when I trade with them. No matter if I’m looking at the OTC market or the NASDAQ, I am always unsure of my predictions due to the fact that I know how these stocks can be manipulated and dumped in a matter of minutes. I’ve been asked if the risk is worth the reward for penny stocks, and here is what I say.
The risks outweigh the reward for penny stocks due to multiple factors that include companies trading on the OTC do not have to file financial documents like a 10-K. Without these documents, you can’t assess a company properly. Even if penny stock companies trade on major stock exchanges, you risk losing money by being misled by misinformation and PR pump and dumps.
In this article, I will detail what penny stocks, then we will take a look at the categories of penny stocks and how they differ from one another. We will assess the risk and reward value of penny stocks and come to understand why they are so risky. Lastly, we will look at regularly traded stocks that we will categorise in terms of “less risk” compared to penny stocks and see how the two compare.
Comparing Penny Stocks To Regularly Traded Stocks
There are a few terms, aspects of trading, and definitions we need to understand before we can precisely understand what a penny stock is and what a regular traded stock is and how the two are different.
Market cap is the total dollar value of a company’s outstanding shares. Investors use this to determine the company’s size and value. This definition and understanding directly relates to penny and regular stock price shares.
What are Penny Stocks
When the market cap for a company is less than the amount of $300 million, their stock is referred to as penny stock. Definitions vary for penny stocks; however, the Securities Exchange Commission classifies penny stocks as companies trading under $5.
Furthermore, you could also look at penny stock in a greyer way and classify them as stock that is cheaper than other stock. So, we could say that 10% of the cheapest stock could classify as penny stocks, and then we would have a range of penny stocks going up as far as $10.
Penny stocks in previous years would refer to a stock price that was under $1; however, with inflation and economic growth, penny stocks have risen to the level of under $5. Traders classify true penny stock as companies that are traded below $1 still. They are called pink sheet stocks, and these stocks are traded on the OTC market (over the counter bulletin boards). Penny stocks that are not traded on the OTC are traded on major stock exchanges.
Why are Penny Stocks Risky?
Lack of Information
Penny stocks are very risky, and here is why. The first and most significant reason they are risky is the lack of information to the public. This aspect only really applies to OTC penny stocks that are under $1. Companies listed on the pink sheets are not regulated by the SCC and are not required to file financial documents for their investors.
Hence, without these documentations such as the 10k, the investors can’t find out their cash flow, operating expenses, and whether these companies generate revenue. This means you are basically trading blindly when trading these stocks.
As for small-cap penny stocks trading above $1 that are listed on the NASDAQ and the New York Stock Exchange, they are required by the SCC to file their financial documents, register offerings and inform investors of important updates to the company.
Therefore, penny stocks that are not pink sheet stocks are a little less risky than true penny stocks under $1 (or maybe not). You can track, make predictions, and trade better with less risk on small cap penny stocks above $1. This is due to more information being available; however, there is a caveat to this.
Remember you have to understand that if a company’s stock is cheap, there is usually a problem with that company and experienced hard times. You can deduce this by the fact that their share price is low. The investors may even have doubts that the company will survive. Due to these factors purchasing and trading in penny stocks, as you can see, is very risky.
However, companies trading on major stock exchanges, even if their shares are low, have demonstrated that they have knowledge of the market, a proven business model, and resources that may lead to attracting investors that could turn their share price around.
Misinformation through PR Pump and dumps
Other factors come into play that make all penny stocks risky and the market very volatile due to the fact that these stocks can be easily manipulated by misinformation and through pump and dumps.
Many penny stock companies will hire a 3rd party and a PR team to promote and sensationalize their company in the news with sensational headlines. These terms could include the companies name and then terms like agreements, contracts, advancement, and breakthroughs.
If you had to read through the articles and look past the headlines, you would notice that the news reported is a fluff piece (made up or hyped up).
These companies take advantage of the fact that most traders and investors, even inexperienced traders, are lazy and do not read through articles or dig deep and research accurate information about the company.
As the price is hiked up, the company’s insiders start to sell and dump millions of their shares on unsuspecting traders and investors. Another strategy the company will use when the shares’ price is hiked up is that they will issue offerings because they are low on money, which will help them raise it.
Some people think companies trading on the major stock exchanges are more regulated and hence, more reliable than penny stock companies traded on the OTC market. However, it is not considered illegal in the SCC’s eyes to release exciting news about a company to its investors. Because of this, the market is now trading in a grey area of information and misinformation.
Penny Stock Overview
Penny stocks are always a risky investment, and it is still better to be skeptical about penny stock promotions, PR releases, and chat room recommendations. Always be sure to do your research and all the necessary work required to find out information about the company in which you intend to invest.
Some penny stock investments can make you a lucrative amount of money; however, if you are an inexperienced trader, don’t have the stomach for how volatile the market is, and get queasy at losing money quickly. Penny stocks may not be your cup of tea.
Regularly Traded Stocks
There is no exact opposite to penny stocks; every different type of investment product is unique. If we have to base regular stocks on criteria like “risk” compared to penny stocks, then we could perhaps consider bonds, vanilla stocks, or even real estate as being opposite to penny stocks. These stocks are of lower risk than penny stocks, but your due diligence is still needed to make predictions and make yourself money.
Regularly traded stocks deserve attention and are not as volatile as penny stocks. The type of trade you do will also affect the type of stock you want to trade, which will relate to your personality. Types of trading that you would consider when trading in regular stocks would be long-term investments and swing trading. We could consider penny stocks to be in the realm of day trading. Penny stocks would not go long term. However, all scenarios and situations are different, so you would have to consider all the factors.
Penny stocks are volatile and are high-risk, high reward; however, most of the time, the risk outweighs the reward, and traders lose a ton of money especially trading on the OTC market where companies are not required to file financial documentation.
This high-risk trend continues because even if a company trades on major stock exchanges, they would sometimes use specific strategies like misinformation and pump and dumps to mislead investors, traders, and the public. This would pump up their stock price, and then they would sell, leaving you better off for worse with worthless stock and you out of money. I would not recommend that any inexperienced traders trade in penny stocks, especially if you do not have the stomach for a volatile market and do not like losing money.
Regularly traded stocks can come in many different forms of investments, and some could include bonds, vanilla stocks, and even real estate. These stocks are reliable for the most part, and you would plan to trade them long term with low reward and low risk.
Whatever you decide to do and how you choose to trade, always remember to do your due diligence to find out all the information you need on a company to make the correct investments, trades, and predictions.
If you want to dabble with Penny Stocks while still staying safe with regular ones, I would suggest you open an eToro account and check out the CopyTrader feature, and see what other Penny Stock Traders are doing.