To be a successful penny stock trader any investor has to understand the risks with buying penny stocks in general. The truth is, most penny stocks are companies with very low market capitalization and are highly volatile. Picking hot penny stocks is as a result one of the most speculative investments a trader can make.
A penny stock trader is someone who is purchasing shares of stock in a company that trades for less than $1.00 per share, or pennies literally. There are many sites and services out there that want to sell the next hot penny stock pick to you so before buying penny stocks consider the following list highlighting the dangers of penny stocks:
- Manipulation of Prices – Penny stocks are extremely easy to manipulate the price in due to the low average volume of shares traded per day (see #4) and low prices. This makes penny stocks prime candidates for a pump and dump type of scheme. Very often on message boards, in emails, newsletters, etc. pumping (or promotion) of a penny stock can be seen to attract investor capital. Once the stock jumps in price the pumper sells out completely leaving the rest of the investors on their own.
- Unregulated exchanges – Penny stocks that trade over the counter on the OTCBB or as pink sheets are not regulated and thus are not forced to meet any specific compliance rules or requirements. This adds unseen risks for any penny stock trader buying a long term position as these securities are exposed to more and different types of manipulation and scams.
- Lack of financial statements – When you hear of a hot stock the first thing a wise investor will normally do is to go and check out the financial statements of the company. Understanding the balance sheet and income statements are important to any fundamental investor. Unfortunately with most penny stocks there are absolutely no financials to observe which means there is no hard data to analyze beyond what is offered by other investors.
- Lack of liquidity – While not the case with all penny stocks, many aren’t very liquid. Some companies may only see $10,000 – $50,000 in stock exchanged per day. This makes attaining competitive prices very difficult and for larger investors selling positions even more difficult.
While buying penny stocks is inherently more risky than normal long term investing penny stock traders are addicted to the extremely quick profit potential. Some penny stocks can move 10 – 20% or more on an average day with positive returns of 100% or more being very common over even a week or two.
And while many investors end up losing significant amounts of money a select few have turned this risky trading into a full time business. Penny stock traders such as Timothy Sykes and Peter Leeds for example have made successful careers centered around buying penny stocks and offering penny stock picks.
All in all penny stocks are a type investing attractive to investors looking to get rich quick and that don’t mind taking on extensive risk. While suitable for some buying penny stocks can be a terrible decision for others as money can go just as fast as it comes.
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