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Do Low Priced Stocks Mean Low Risks for Penny Stock Investors? |
Many people who are new stock trading think that penny stocks are the obvious and logical choice. The word penny indicates that the investment is small enough that they won’t have to risk a lot for a great deal of potential.
Many people who are new stock trading think that penny stocks are the
obvious and logical choice. The word penny indicates that the
investment is small enough that they won’t have to risk a lot for a
great deal of potential.
The truth is that all investors need to understand that while penny
stocks may not cost a lot per share and you seem to be able to buy a
lot of shares for minimal cash, it could cost you more if the company’s
stock that you are trading goes away. Many companies at this stage of
their corporate development need cash and capital. Many of these small
public companies use their stock as equity in raising operating capital
by various means, and some don’t get the funding they need or don’t
turn the corner on profitability before their funding resources run out
and simply cannot continue as a “going concern” and have to shut down
their businesses.
Penny stock investing, just like any other investment opportunity,
requires the trader to look carefully at the company’s financial
history and expected future earnings as well, if you can find it though
SEC filings.
Brokerage firms that help penny stock investors trade in this type of
transaction, are required to disclose the risks using a document that
tells the customer exactly what the risks are before they choose to
hand over their money.
Penny stocks, unlike other kinds of higher-priced stocks, aren’t traded
as often, so one of the larger risks involves being stuck with penny
stocks once you own them. And since they’re not traded often, the
pricing you’re seeing can be inaccurate or out of date.
The term used to describe the degree of trading volume and activity is liquidity.
Liquidity is defined as:
The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity.
The ability to convert an asset to cash quickly.
So, liquidity is an important factor in trading penny stocks. Typically
there are sellers there waiting to accept your offer so you can buy
stock in a company. The trick is being able to sell it when, and at
what price, you want for it. If a stock is not liquid and has minimal
trading volume, you may be stuck with the stock not being able to trade
it if the stock price starts to fall, or not being able to trade or
sell it when it appears to be at a price you want to sell at.
Typically, the more consistent trading volume there is in a stock, the
safer it will be to trade, at least in so far as readily being able to
buy and sell a stock on a consistent basis.
Perhaps the biggest risk in investing with penny stocks is the mere
hype that goes along with it. There is a lot of spam associated with
many penny stocks that we all receive each day. There are also
reputable and some disreputable IR companies out there promoting micro
cap stocks. Many of these companies can be a good resource for more
information on micro cap and penny stocks, but look beyond the hype and
dig into the facts via your own research and base your decisions on all
of the information you come up with.
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The first thing you as a new investor should be aware of is the high risk involved with small cap investing. When you buy a company like CSCO, IBM, MSFT, GE, or DELL, you are buying a quality company, backed by big names and run by hundreds of managers and consultants. Small cap companies are often run by only a handful of people. Often there is the CEO/founder/president, perhaps a COO and a few other employees.
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Different people have different definitions of what a penny stock is, but most define it as a stock that is trading for less than one dollar.
Others consider a true penny stock to be a stock worth less than one dollar that’s trading on a major stock exchange. It all boils down to who you ask. It really does not matter that a stock is traded on a major exchange because the defining element of a penny stock is the price of the stock and not the exchange on which it is traded.
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Many people who are new stock trading think that penny stocks are the obvious and logical choice. The word penny indicates that the investment is small enough that they won’t have to risk a lot for a great deal of potential.
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You may have heard many small cap stocks described as an over-the-counter bulletin board stock, or an 'OTCBB' stock, for short. The bulletin board quotation system is indeed considered an 'over the counter' market in that there's no physical 'manned' exchange. But, it is not part of the NASDAQ stock market. Instead, the OTC Bulletin Board is a network of many market makers, each reporting current bids, offers, and completed trades to a centralized computer. The NASD has no authority over, or connection with, companies with bulletin-board-traded stocks.
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