Investors are on the lookout for balancing rewards with risks. Penny stocks are highly volatile and subject to easy manipulation by forces other than market-determined value. This may make long-term investors wary of how safe penny stocks might be in the long run.
Penny stocks are not good long-term investments because their volatility presents a high risk. If you want to invest over a long period, it is ideal to park your savings in an index fund or a diversified portfolio, including blue-chip stocks.
In this article, you will learn the truth about penny stocks. You will also find out how the penny stocks come to be and why they have the reputation they have. More importantly, topics like best practices in penny stock investing and alternatives to penny stocks will be covered.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
What Are Penny Stocks?
To understand whether penny stocks are right for you or not, you must understand what these stocks are. Typically, a penny stock represents a small company’s share trading below the rate of $5. These stocks are traded using over-the-counter electronic transactions, through privately owned groups, or even the New York Stock Exchange.
There are two types of penny stocks. The first are ones under a dollar. These are traded exclusively over-the-counter, while stocks that go over three dollars can be traded at stock exchanges depending on whether the other criteria listed by the specific exchange are met.
Penny stocks, as the name implies, are infrequently traded via small companies. They suffer from illiquidity and are hence challenging to be sold. Market-appropriate prices are challenging to find, and resultantly, the bid-ask spreads. There is high speculation involved in the penny stocks because, inadvertently, the investors could lose a generous proportion or the entire investment.
Why Penny Stocks Have a Bad Reputation?
As we have already established that penny stocks have the potential of high returns, there is still a lot of room for exploration about the stocks’ bad reputation.
Risk of Fraud
Frauds are prevalent in penny stock trades. The lack of clear information on the subject has facilitated the Ponzi schemes. The elementary formula of demand and supply is applied to manipulate investors into buying penny stocks.
Once the price rises, the sinister minds wash their hands of the worthless stock at a high margin of profits, which leads to the downfall of the fickle price. In the end, the investor is left with plenty of stocks that are worth less than the last sheet on a roll of paper towels.
Devastated Companies
The companies that offer penny stocks are usually under the strain of an economic calamity or suffering from obscurity. The ill-repute of the company can severely impact the returns and hence prove to be a little impractical. Trending industries such as information technology have higher rates of investment without any specific firms winning the race.
Impulsive Pricing
Penny stocks suffer from impulsive pricing due to their potential of high gains for the investor. These volatile stocks can deliver enormous losses that can devastate the investor. That is why buying large quantities of penny stocks is risky.
Lack of Liquidity
The ease of selling securities is called liquidity. It is one of the critical reasons for stock investment. Penny stocks are illiquid due to their volatility and lack of sufficient investors. This makes it somewhat confusing to find the right rates at the right time to liquidate the investment made.
Cryptic Information About the Stocks
The smaller scale of companies that introduce penny stocks is not reliable for the information around the securities. There was no obligation to file financial reports for the knowledge of the investor in the past. However, regulations have been introduced to brokers.
Companies with undisclosed financial records are prohibited from issuing securities. Since the changes are relatively recent, it is evident that a significant amount of time is required to increase awareness.
Can You Get Rich With Penny Stocks?
Penny stocks are usually tagged as high-risk securities with little regulation and lots of speculation. Penny stocks are cheap and can help you climb up the stairway of success by investing in an obscure company. Imagine if you had invested in Amazon’s stocks when it was a little more than a bookstore.
You could have been sitting idly with at least a few grand in the form of dividends. Since penny stocks involve minor investments, the trading is rapid and more like a ruckus. In a nutshell, getting rich through penny stocks depends more on luck than anything else. That being said, if you have a well-informed and refined strategy to trade Penny Stocks, there is definitely money to be made trading them.
Long Term vs. Short Term Investing: Which Is Better for Penny Stocks?
Terms of investment depend on the investor’s choice. From trading short-term securities for a few minutes to holding onto them for a few months or holding onto long-term investments for a few decades, everyone has a different approach to the liquidity of their investment.
High-frequency short term-trading is a favorable solution for individuals seeking short-term advantages. Limited time and resources create a favorable environment for short-term investing in penny stocks. All in all, short term investments mitigate some risk.
Stock market gurus advise that it may seem tempting to hold onto penny stocks as a long-term investment, but it is nothing but a hassle in reality. The hopes of large gains are fraught with risks. This is why it is ideal to aim for twenty-five percent of profits without falling prey to penny stocks’ hazards.
Since penny stocks are traded in low volumes, it is ideal to invest in a frequently traded company. This way, you can maintain the liquidity of your stocks. The capital gains taxes for short-term investments are significantly higher than long-term investments.
They are hence proven to be better used as a short-term investment.
Tips on Investing in Penny Stocks
Do you still plan on investing in penny stocks? Here are a few quick tips for investing in penny stocks:
- Remember that “high-quality above high-quantity.” You are advised to invest in companies with clear records available to the public. Avoiding companies with murky details are the first step in the right direction.
- Obtain expert opinion before investment. Finding a professional broker will keep you safe from fraud.
- Run farther from the dubious markets. Unpredictability is typical in penny stocks; this is why the second you see unsolicited activity about penny stocks, you must run in the opposite direction.
- Be prepared to lose all of your investment. Since penny stocks are unstable, we whole-heartedly advise our readers to be prepared to part ways with the whole investment.
Penny Stocks Alternatives
Penny stocks are not everyone’s cup of tea. If you want to succeed at investments but play it safe, then here are a few alternatives you can try instead:
- Crowd-funded real estate: Real estate investors have recently accepted crowd-funding as a substitute for financing more extensive projects. The investments solicited through platforms offer benefits to accredited investors. The returns on this investment are always safe and higher than the expectations.
- Gold and precious metals: Physical metals such as gold can be purchased in bullion coins and bars or through gold-exchange traded funds. Investing in ETFs for gold implies zero ownership on the metal itself, but on the other hand, physical gold can be saved as an asset for liquidity.
- Blue-chip stocks: Blue-chip stocks are the most comfortable form of stock investment. Their characteristic benefits include guaranteed rewards, high returns on equity, higher ranking, and attractive repurchase opportunities.
Author’s Recommendations: Top Trading and Investment Resources To Consider
Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.
- Roadmap to Becoming a Consistently Profitable Trader: I surveyed 5000+ traders (and interviewed 50+ profitable traders) to create the best possible step by step trading guide for you. Read my article: ‘7 Proven Steps To Profitable Trading’ to learn about my findings from surveying 5000+ traders, and to learn how these learnings can be leveraged to your advantage.
- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
- Best Trading Courses You Can Take For Free (or at extremely low cost): I reviewed 30+ trading courses to recommend you the best resource, and found Trading Strategies in Emerging Markets Specialization on Coursera to beat every other course on the market. Plus, if you complete this course within 7 days, it will cost you nothing and will be absolutely free! Click Here To Sign Up Today! (If you don’t find this course valuable, you can cancel anytime within the 7 days trial period and pay nothing.)
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Conclusion
Investment in penny stocks requires a comprehensive understanding of the market and its trends. While you can invest in penny stocks for short-term profit (if you know what you are doing), it is ideal to seek professional advice before making any investments for the long term.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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