The Pros And Cons Of Trading Penny Stocks

Trading so-called “penny stocks” can be fun, profitable, challenging, educational and frustrating. These low-priced securities, formally called “micro-cap” stocks, have been around for years and have enjoyed ups and downs in popularity. Here are a few of the positive and negative aspects of trading penny stocks.

Trading Penny Stocks

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Penny Stocks to Watch

After setting up an online brokerage account that allows you to trade micro-cap shares, it’s easy enough to find lists via search engines. That’s because there are dozens of sites that specialize in offering lists of penny stocks to watch, “fast-moving micro-caps,” and similar low-cost stock shares.

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They’re Inexpensive

There’s no agreed-upon definition of “penny stocks,” but most experts use the term to refer to shares that cost less than $5 per share. Indeed, there are lots of decent investing opportunities for buyers who prefer shares in the $2 to $4 range as well.

You Better Do Your Research

It’s imperative to do a substantial amount of research before investing in any low-priced stock, especially shares with price tags under $5. Learn as much as possible about what the company does, who runs it and how long they’ve been doing what they do. Many investors shy away from penny stocks of companies that have been in business less than three years or have frequent personnel changes.

Prices are Volatile

Spend time on your favorite financial website and observe the daily fluctuation of penny stock prices. While some go nowhere, a good number of them have daily price ranges that far outstrip price moves among traditional shares. Anyone who intends to invest in micro-cap stocks should pay attention to average daily price changes for a few weeks to get a feel for the world of penny stocks.

Manipulation is Possible

One of the big downsides of penny stock investing is manipulation. Owners of small companies can take action that directly affects share price by huge percentages. When a share that costs 50 cents, for example, drops 30 cents, that translates to a 60 percent decrease of total value. Major investors can lose thousands of dollars in minutes, and all it takes is for a company executive to announce the cancellation of a big contract or the firing of a key employee.

News and Information Can Be Hard to Find

For a large number of penny stocks, it can be nearly impossible to obtain objective news about the companies, directors and financial prospects. Some of the lowest-priced stocks are issued by corporations that have only been around for a few months and are virtually unknown to the investing public.

You Can Earn Significant Returns

By employing careful risk-reduction methods and doing lots of research, investors stand to make large returns on penny stocks. Today’s biggest winners typically choose shares issued by established companies. Another part of a smart investing strategy is a preference for shares priced in the $3 to $5 range.

You Can Lose a Lot

Some micro-caps, especially ones priced at the low end of the micro spectrum for less than 50 cents per share, have a tendency to disappear when firms go belly up. Investing in these tiniest of all stock offerings can mean quick losses. To deter that risk, most penny stock enthusiasts’ own shares in dozens of companies with prices ranging from one to five dollars per share.



About the Author

Ankur Shah
Ankur Shah is the founder of the Value Investing India Report, a leading independent, value oriented journal of the Indian financial markets. Ankur has more than eight years of equity research experience covering emerging markets, with a focus on India and South East Asia. He has worked as both a buy-side investment analyst for a global long/short equity hedge fund and a sell-side analyst for an emerging markets investment bank. Ankur is a graduate of Harvard Business School. You can learn more about his latest views on global markets at the Value Investing India Report. -- He can be emailed at AnkurShah47@gmail.com