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Friday, September 7, 2012

Investment Option: Investing in Penny Stocks

What are Penny Stocks?

Perhaps you have asked yourself this question and many others in your quest to understand this investment option, penny stocks. Are they for first time investors or not? What is the risk of this investment options? And most importantly, are penny stocks for me?

Penny stocks, as the name suggests, is a stock with a value of $5 or less per share. Unlike regular stocks, penny stocks are not traded in the New York Stock Exchange.  They are, instead, traded through on over-the-counter markets via pink sheets (electronic quotation systems). Smaller companies with less than $5 million in assets or those that do not possess tangible assets like equipment and buildings are more likely to issue penny stocks than larger more established corporations.


When dealing in regular stocks, you are more likely to find their trading prices in your daily newspapers or online. However, determination of penny stock’s share prices is a bit complicated. In an archetypal transaction, your agent (broker dealer) , arranges a trade for you based on the bid price (the amount you are willing to pay for that particular stock) and the ask price (the price the seller is willing to sell the stock). The difference between the ask price and the bid price is the spread and it determines how much money you lose or make.

Risk and Profitability

The major risk with penny stocks is the complexity of the transaction. The fact that the commission to the broker is determined by the amount of spread can make it difficult for you to make money through penny stocks. For instance, the broker my further his/her own interest, not yours. Another risk is the fact that penny stocks are offered by start-up companies with no proven track record. This is risky, as you can lose your money faster than you invested it. Surprisingly, the gambling nature of penny stocks attracts investors who are eager to make some quick bulk cash and move out.

Why Invest in Penny stocks?

The reasons why a trader may want to get involved in penny stock trading is as diverse as the traders themselves.

Sometimes you are a new investor who would want to learn the basics of trading shares, and the low-priced penny stock investment seem to be the best starting place.

Advanced investors may also try their luck in this investment option to play pay with some risk money or hedge a position.

Maybe you have an inside information of the potential and prospects of a company you work at, and you want to invest in their stock before the business takes off.

Penny Stocks are exciting and fun, which is another motivating factor for others. It is kind of high-stakes hobby.

Despite all these varied reasons and ambitions, the main reason investors get involved in penny stock trading is to make some money to get rich or richer.

A combination of the above reasons may act together to push you into the penny stock market.

Why would you get involved in Penny Stock Trading?

  • To make money

  • Enjoyment/excitement

  • You have inside information of the profitability of the issuing company

  • To increase your portfolio risk/reward exposure

  • To hedge strategies

  • To diversify your portfolio

  • The ones big stock you held took a price drive forcing you into unintended penny stock holder

  • To learn how to trade in penny stocks or just stock trading in general

  • You do not want to be left out, penny stock is the talk of town

  • You strongly believe the issuing company’s value will explode

So, are Penny Stocks Suitable for Me?

The suitability of penny stocks as an investment option will depend on many factors, and you are the sole person who can ascertain if you need them in your investment portfolio.

Factors to consider include, but not entirely limited to:

  • Your investment and financial position

  • Your risk tolerance

  • Your investment experience level

  • Your expectations as far as returns are concerned.

My take

As the famous saying goes, a penny saved is a penny earned. However, when it comes to the high-risk penny stocks world, a penny invested can turn into a penny easily lost. If you don't have sufficient amount of money to invest in big stocks, you may be tempted by the low cost and invest penny stocks. However, you should do so with extreme caution.

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