There is a great desire for people and especially inexperienced to invest in penny stocks. It’s unfortunate that some end up losing a lot of their money like a blink of an eye.
However, most people know, but they take the risk. In business and gambling, there is a saying that the higher your risk, the higher the potential of getting more returns. Moreover, when you invest through the right companies, you will get huge returns at the end. So, when you become comfortable with risking versus the return trade-off and then have a clear understanding that it’s easy to lose your money, penny stocks can play a vital role in your portfolio.
The Risks Associated With Penny Stocks
If you don’t know about “penny stocks,” they are the publicly traded securities that have a market capitalization and low stock price. According to the Securities and Exchange Commission, a penny stock is a security that will sell costing less than $5 per share.
Even though, the stocks ranging between $7 and $10 can also be in this penny stock class and especially when the market cap is that low. In an organization, you can determine its market cap through multiplying the stock price with the outstanding number of shares.
There are reasons why penny stocks can be considered as speculative and high-risk investments. Most of these companies having penny stocks are tiny in the market. For example, when it has a market capitalization of $100 million can be said to be a drop of water in an ocean because there are large-cap giant companies that carry more than $500 billion of the markets value.
However, these penny stocks can be those brand-new organizations that lack any gains from its operations. Most of these companies are not proven because they have a short operating history and therefore lack a clear track record.
On the other hand, large-cap organizations are those that have operated for some time and have generated significant profits for reinvesting in its business for continued growth or even paid dividends to its shareholders.
Besides, it’s essential to know that a company trading as a penny stock can also be an organization that is approaching to bankruptcy level. It’s, therefore, a high risk for you to invest in penny stocks due to its extremely high speculation.
For penny stocks in the market, they trade via pink sheets or Over-the-counter because they can’t meet the exchange-listing requirements. In the NASDAQ or New York Stock Exchange, these over-the-counter stocks become less regulated and therefore a challenge for an investor to know crucial details about the organization before he can make investments.
These penny stocks, on the other hand, are traded infrequently and therefore hard for you to purchase or sell order. Due to lack of trading volume, results in larger bid-ask spreads, and it’s the difference that occurs between how much the buyer will purchase the stock for and what the seller will sell it for. There is a lack of liquidity, and you might end up paying a higher price than you expect or even sell it at a lower price. The worst scenario might happen when you might lack a buyer to purchase your shares because there isn’t a lot of volume.
Since these penny stocks have loose regulations and thin trading, they have become a target for manipulators, stocks promoters and scammers. So, as an investor, you must be mindful on the pump and dump schemes that result from scammers purchasing shares of a specific stock and use misleading or false statements and pump up the share price where they end up selling their stocks at an inflated cost before the value collapses inevitably.
As a wise investor, you need to avoid these pump and dump scams because you can end up losing most of your investments. If you have a plan to actively trade penny stocks, you need to keep in mind that you might get charged more by the brokerages for transactions.
Types of Penny Stocks You Need To Know
So that you can understand the types of trading orders and the way you can use them, you will first have to learn about buying and selling stocks. So, when you are buying or selling shares in any stock of your choice, there are two main types of orders you have to choose: limit orders and market orders.
However, it’s essential for you to understand the orders before you can trade any equity, but with penny stocks, the distinction becomes explicitly crucial. Even though the low-priced shares are thinly traded and volatile by nature, when you use the wrong type of order can cost you a lot.
a) Limit Orders
When you want to place a limit order, you set the price that you are willing to pay for the total shares you are planning to buy. For example, if you are planning to purchase a limit order of 500 shares and the cost of each share is 40 cents, you can get many shares available at the cost, but if they are selling at a lower price, you will also get them at a lower price. If you find that the share asking price is 41 cents, your trading order can’t take place until a seller lowers the cost to your value or less.
The advantage behind the limit order is that you can never pay more than what you stated in your price. It’s similar to a limit sell order, where you can only sell the shares after the buyer meets your selling price; otherwise, no trade can take place.
b) Market Orders
If you want to place a market order, you need to be ready to pay the best price that is available for stock. In an example, when a penny stocks asking price is 45 cents, then placing a market order you will pay the asking price. In this case, 45 cents.
However, market order’s downside is that you are not able to control the price that you use for trading the shares. Due to the best available price, you can, therefore, buy or even sell all the shares. In the end, you can end up receiving far less or paying much more than you expect.
Why People Purchase Penny Stocks For Trading
There are many potential risks associated with penny stocks, but you can wonder why people even bother trading penny stocks. It’s a simple reason: when you choose the right kind of stock, it’s possible for you to double or triple your invested money within a short period. However, selecting a company that grows with time and you hold your stocks for a long term, you will not have a limit to the gains you could receive.
Even though it’s hard to find, the best penny stocks companies can run their profitable business having the potential for growth and end up becoming large-cap stocks leading to a tremendous profit especially for its early investors.
It’s like any stock that you can buy, and you will, therefore, need to do due diligence before you start making your investment. For example, you can read through cash flow and income statements and see how a company is profitable, check its balance sheet to learn about its assets comparing with debts. When you have the information, it’s easy to spot and weed out scams and find legitimate companies.
However, it’s not for faint of heart to invest in this penny stocks. You have to accept the possibility of losing even 100% of the invested amount within a short period. So, before taking such a risk, it would be better for you to carefully do your extensive research so that you can manage your risks better.
On the other hand, small companies always have room to grow. Market share is the primary determinant whether the company is developing – when an underlying company produces in its market share, it’s the best indicator of it having success. You need to know that growing a market share can take some time before it shows up in its earnings. However, there are indicators that a company is tremendously increasing in the market share:
Revenues and sales: The sales and revenues will tell you how much money that a company brings after selling their products and services.
Employees: When there is growth in employees, it’s a clear demonstration that the organization is focusing on capturing some more sales. Moreover, it can show that the organization needs more workforces to meet its customers demands.
Mergers, amalgamations, and acquisitions: If two or more companies decide to merge into one or maybe a more massive corporation decide to buy a small company; a 10 cent stock can increase its value fast.
Recurring billing: it’s easy for you to analyze a penny stocks growth that derives revenues from subscription fees and recurring billing. So, you can track the recurring billing customers so that you can have a clear presentation behind the underlying growth and also future revenues.
