Individual investors across the country consider penny stocks to be Wall Street’s Wild West. This is because these stocks hardly cost any penny, and are detached from all the glitz and glam that all the other stocks at the NYSE and NASDAQ garner. The Securities and Exchange Commission considers anything under $5 to be penny stocks.
Although away from all the attention, penny stocks have gained notoriety due to scams and corruption in the past.
Buying penny stocks
These stocks are not usually traded on normal exchanges, but you can still buy them through your local stockbroker. This is regardless of the fact that it’s listed on major exchange or not. Penny stocks are traded on stock listing services like OTCBB or Over The Counter Bulletin Board and pink sheets. However, unlike OTCBB, pink sheets are not verified by SEC hence the stock listings provided by pink sheets might not be legitimate.
It is the volatility of the penny stocks that make the investors put in their money into penny stocks keeping in mind all the risks involved. People invest in penny stocks because they believe that the stocks will jump from $0.05 to $5 in under a week, which has happened in the past. There are stories of investors who have made mints out of pennies.
But before you decide to invest in penny stocks, be aware of the following risk factors:
- Penny stocks have a very low liquidity and have poor reporting standards because they are listed on pink sheets. This makes even the most legitimate penny stocks risky.
- Penny stock trading is not frequent, which makes it difficult to sell once you own them. The reason penny stocks are difficult to sell is because it is difficult to find quotations to find certain penny stocks and price them accurately.
- Another cause of concern is that companies whose stocks are listed in the OTCBB and Pink sheets lack stringent reporting standards. As SEC allows minimum filing for companies to be listed on the OTCBB, it makes trading in penny stocks less legitimate.
Now that you know the risk factors, here are some tips to help you buy legitimate penny stocks:
- When you are buying penny stocks, make sure that you consider three main factors – the underlying business, financials, and footnotes.
- A company’s underlying business is more important than exchange-traded stocks. Penny stocks are a home to “shell” companies. Shell companies are those companies that have legitimated corporations but do not have any business operation as such. These companies are used as baits by scammers to set up for “pump and dump” stocks.
- Look for companies that have sustainable business operations. Penny stock’s financials are equally important for any investors. Check for the quality of the financial statements; this will make penny stocks easy to deal with.
- At the end, penny stocks can be inherently risky and can be a fodder for a lot of scammers. But, at the same time, it can make you a lot of money if you know where to look and how to check for the authenticity of these stocks from the Wall Street’s Wild West.