Imagine you bought a few shares from a small company for a few dollars, and sometime later, the company’s net worth increased to multi-billion dollars. You earned an explosive amount of profit, and life is all good. This is the dream that penny stocks sell. But this isn’t unattainable either.
Penny stocks are those stocks that are priced at less than 5 dollars per share. While some penny stocks may trade on the New York Stock Exchange, most of them are traded on over-the-counter transactions. These low-priced stocks are highly volatile, meaning they have substantial potential for gain but also come with a high level of risk.
To mitigate the risks of penny stocks, you must follow some measures and find a trusted stockbroker. For instance, trading penny stocks on TD Ameritrade can be very beneficial if you are just starting. Let us look at how penny stocks are traded, how they are misused by scammers, and measures to mitigate the risks.
Where Are Penny Stocks Traded?
The Security and Exchange Commissions define penny stocks as those stocks that have a market capitalization of less than $250 million dollars. These are primarily traded on the so-called pink sheets or the over-the-counter bulletin boards. Because these stocks don’t have stringent regulations, they are subjected to discrepancies.
Some investors may be highly enticed by the absence of stringent regulations, allowing them to earn high returns. However, one must also know that high returns come with high risks, and trading on pink sheets or OTC transactions comes with the potential of unimaginable gains and losses.
How People Get Scammed With Penny Stocks
Various scams are circulating in the market when it comes to trading on penny stocks.
- The infamous pump and dump scheme: In this scheme, a group of fraudulent individuals artificially inflate the price of penny stocks and sell them at the inflated price. This leaves investors with worthless and devalued stocks.
- Reverse merger: This scheme involves a reverse merger transaction. Here, a private company (that is often financially troubled) acquires a publicly traded company. This helps the company to artificially inflate its stock prices, leaving the investors with significantly depreciated stocks.
- False advertising: Anyone can be a guru on the internet. Some false advertisers can market a penny stock in such a way that it creates a high demand. Be cautious of these dubious advertisements and too-good-to-be-true returns.
Even though penny stocks come with high risks, they have the potential for explosive growth. For example, Amazon started as a penny stock company, and look where it is now! Since most of the companies are in the early stages of development, careful investments can yield substantial returns.
Mitigating the Risks
The following steps can prove invaluable in helping manage the risks of investing in penny stocks:
Research: Thoroughly research before investing in any penny stocks. You may find falsely promoted stocks with enticing gains. But remember, there is a difference between promotion and research. A well-researched report will support their claim with data and statistics. Additionally, various offshore rackets love scamming on penny stocks because there are no stringent regulations. They buy penny stocks at cheap prices and sell them to uninformed investors at a manipulated price. Therefore, due diligence is very crucial before investing in penny stocks.
Risk management: Penny stocks are very volatile; therefore, invest only as much as you can afford to lose. Using limit order can help reduce potential risks. Also, stay up to date with what is going on in the market to assess potential risks and diversify your portfolio to spread the risk across different stocks. Moreover, to manage your portfolio, you must find a trusted stockbroker to guide you to mitigate the risk.
Conclusion
Investing in penny stock comes with many rewards and risks. Penny stocks have a low market price but are highly volatile and come with low market capitalization. Moreover, their low liquidity makes them a risky investment. Therefore, knowing about these risks and how to mitigate them is crucial before delving into the investment landscape.