Penny stocks refer to shares of a small company that trades for less than $5 per share and are generally quoted over-the-counter.
What are penny stocks?
Originally, any stock that traded for less than $1 per share was considered a penny stock. Now, the U.S. Securities and Exchange Commission (SEC) has updated it to a share issued by a very small company that trades at less than $5 per share. Unfortunately, the majority of penny stocks will cost more than a penny.
Related: Personal finance tools to master your money
They’re also referred to as a microcap or nano-cap stocks.
Microcap refers to companies that have a low market capitalization of less than $250 or $300 million. However, it’s common for these companies to have market capitalizations that are far less.
Nano-cap stocks have an even smaller market capitalization of $50 million or less.
Just like any other investment, there are risks. However, the reason that people are willing to invest in them is the volatility.
It’s possible for penny stocks to jump from less than $1 to more than $5 in a relatively short time. Although it’s not common, people do believe that they can get lucky.
Related: How to make money quickly
You should also be prepared to lose money just as easily. Since the companies are very small, you need to have a high-risk tolerance. There’s a high potential for reward and a high potential for losses.
When you’re trading microcap or nano-cap stocks, earning small increments is the safer way to trade. If you try to get rich quickly with penny stocks, there’s a good chance that you may lose money, so be careful.
How to buy penny stocks
Most penny stocks trade on the over-the-counter market (OTC). They’re quoted on OTC systems, such as OTC Bulletin Board, which is an interdealer quotation system, or OTC Markets Group, which is privately owned.
Some are traded on securities exchanges, such as NYSE, NASDAQ, or foreign securities exchanges, but it’s not as common.
Since it’s considered high-risk trading, you shouldn’t use your emergency fund or retirement savings to invest. Instead, use disposable income, or “play money”.
Take the following steps to invest in penny stocks:
- Do your research.
- Select a broker.
- Choose a stock to trade.
- Keep up with news or join a day trading community.
Potential risks and scams
Since penny stocks sell at low prices, there’s room for plenty of growth. However, it’s still a risky investment for several reasons.
First, they may trade infrequently or in low volumes, which means that it may be difficult to sell penny stock shares once you own them, or get an accurate price quote.
Second, the risk levels are high because many of the companies are new and have no proven track record. They might not have assets, operations, or revenue because the product may still be in development or testing.
Also, there isn’t a minimum listing standard, which means stocks on the OTCBB don’t have to fulfill the same minimum requirements that stocks on the exchange do.
Lastly, fraud can occur because these companies don’t have to file financial reports with the U.S. Securities and Exchange Commission.
From 2008 to 2013, there was a huge scheme conducted by Zirk de Maison, who stole approximately $39 million from investors. He convinced a large number of investors to buy shares, which drove up the price.
Maison pled guilty in 2015 and is now in prison, along with seven others who helped him.
That’s one major example of what can happen if you’re not careful. Do your research and trade carefully. You should be prepared for the possibility that they may lose your whole investment.
However, by trading well, the small increments can lead to great results. There are many stories of people who became millionaires from trading penny stocks.
Frequently asked questions
Is it illegal to buy penny stocks?
Penny stock trading is risky, but it’s not illegal.
What is the most successful penny stock ever?
Monster Beverage, Concur Technologies, and Ford Motor Company are several examples of companies that started as a penny stock.
Has anyone ever got rich off of penny stocks?
Tim Grittani and Tim Sykes are two people you may have heard of or seen advertisements from. They both have become millionaires from penny stock trading.
Conclusion
Penny stocks aren’t for everyone, especially due to their high level of risk. However, if you’re willing to spend time learning the markets, how to trade them, and endure the risks, you may be able to earn significant returns.
More resources:
Featured image courtesy of Pixabay.
About David Em
Founder
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.
