Investing & Finding Value in Penny Stocks

What is a Penny Stock?

This is the million dollar question you have on the tip of your tongue. What is a penny stock? Is it worth a penny? Can you make a profit from it? These are all viable questions that any potential penny stock investor should be asking. Penny stocks are stocks that trade for less than five dollars per share, which are traded over the counter on the OTC Bulletin Board and Pink Sheets. Most penny stocks are worth very little, and the real money comes not in their individual value, but in the bulk value. Typically, penny stock share volumes are traded in the hundreds of millions each day. Penny stocks are also known as a stock that trades outside the New York Stock Exchange and the NASDAQ, as well as AMEX. The Securities Exchange Commission defines a penny stock as a low-priced, speculative security of a very small company that does not take into consideration any market capitalization.

What Lures Investors to Penny Stocks?

Investors choose penny stocks because they have a low price but there is the potential for rapid growth. On the flip side, there is also the potential for severe loss as well, causing many penny stocks to lose their value over the course of the long-term. For this reason, penny stocks are high risk, but with high risk come high rewards as well. Risks for investors come in the limited amount of liquidity, the lack of financial reporting with penny stocks and the potential for fraud. Given that, with the large amount investors want penny stocks because if the stock price rises only a small fraction, there can be a large percentage of swing in the value of their shares. Investors also like that penny stocks are a low stock price investment, which also gives the impression that the investor is buying a large amount of the company.

Where Do the Risks Come From in Penny Stocks?

There are several risks associated with penny stocks that investors need to be aware of, especially new investors. Rapid changes in the demand and supply of a penny stock can cause the stock to go up or down quickly. These stocks are highly volatile as a result. The lack of liquidity also makes it very difficult to sell a penny stock. The combination of the volatility of penny stocks and their lack of liquidity makes them more vulnerable to manipulation by scammers and unscrupulous investors.

Another problem with penny stocks comes from the fact that there are virtually no requirements for the stocks to be quoted on the OTCBB. Often, companies that fail to meet the standards of the New York Stock Exchange and the NASDAQ, relist themselves on the OTCBB and Pink Sheets.

What Is Over-The-Counter?

Over-the-Counter is done through market makers on the OTCBB and Pink sheets and primarily relate to penny stocks. OTC stocks are not traded or listed on the stock exchanges. OTC stocks like penny stocks have no reporting requirements, leading them open to fraud, and only have to meet the minimum guidelines of the OTCBB and Pink Sheets.

The Proper Way to Invest in Penny Stocks

If you want to invest in penny stocks, you should find an advisor who has a track record of success. Make sure their record of success is documented by the Hulbert Advisory Service, while paying special attention to the previous recommendations of this investor. In your portfolio, if you want to diversify it, having ten percent of your portfolio made up of penny stocks is a disciplined approach. Anything higher leaves you too open for a major loss because of the volatility of penny stocks.

The Wrong Way to Invest in Penny Stocks

Penny stocks are wide open for fraud and spammers use that to their full advantage. One method is the pump and dump approach. In this, a scammer will buy a stock and pump it up by sending out spam e-mails and going on investment forums. When buying surges on the stock, they will dump it. Don’t fall for this if it happens to you.

While penny stocks have the potential for a big profit, that big profit comes with high risk. You don’t want to buy penny stocks and load up your portfolio with them, which is just asking for trouble. A better approach is to make up ten percent and under for penny stocks in your portfolio. This conservative approach will protect you. Be aware of investors who are trying to scam you. Remember, if it seems too good to be true, then it probably is.

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