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Sound Advice: September 6, 2023

All About Penny Stocks

Penny stocks refer to shares of small companies that trade at low prices per share, typically under $5 in the U.S.  These stocks are often associated with small-cap or micro-cap companies with relatively low market capitalizations (stock price multiplied by the number of shares outstanding).  Here are some key points to know about penny stocks:

  1. Low Price and Market Capitalization: Penny stocks have a low price per share, making them accessible to investors with limited funds.  The low market capitalization also means they are generally more volatile and less liquid than larger, more established stocks.
  2. Higher Risk and Volatility: Penny stocks are considered speculative investments and carry a higher level of risk compared to more prominent, well-established companies.  Due to their small size and limited financial resources, penny stocks can be more sensitive to market fluctuations and company-specific news.
  3. Lack of Information: Many penny stocks are traded on over-the-counter (OTC) markets, which often have fewer regulatory requirements and reporting standards than major stock exchanges like the New York Stock Exchange (NYSE) or NASDAQ.  As a result, there may be limited information available about the companies, making it challenging for investors to conduct thorough due diligence.
  4. Potential for Large Gains (and Losses): Penny stocks can experience significant price movements over short periods.  Although some investors are attracted to the potential for large gains, it’s essential to recognize that the same volatility can lead to substantial losses.
  5. Lack of Liquidity: Penny stocks may have a limited number of buyers and sellers, which can make it difficult to buy or sell shares quickly, especially in large quantities.  This lack of liquidity can result in wider bid-ask spreads, potentially leading to higher trading costs.
  6. Risk of Fraud and Manipulation: Given the lack of stringent regulation and reporting requirements for penny stocks, they are sometimes associated with pump-and-dump schemes and fraudulent activities.  Some unscrupulous individuals may attempt to artificially inflate the stock price before selling their shares at a profit, leaving other investors with significant losses.
  7. Not Suitable for All Investors: Due to their higher risk and speculative nature, penny stocks are generally not suitable for inexperienced investors or those with a low risk tolerance.  Investors interested in penny stocks should be prepared to conduct thorough research and understand the risks involved.
  8. Listing Requirements: In some countries, there are specific listing requirements for stocks traded on major exchanges.  If a stock fails to meet those requirements, it may be delisted or relegated to trading on OTC markets.

Penny stocks can be enticing due to their low price and the potential for significant gains.  Even so, they come with substantial risks and limited information, making them unsuitable for many investors.  If you are considering investing in penny stocks, it’s essential to conduct thorough research, understand the risks involved, and be prepared for the potential volatility in this market segment.  Diversification and a long-term investment approach are generally considered prudent strategies for managing risk in any investment portfolio.

N. Russell Wayne, CFP

Any questions?  Please contact me at nrwayne@soundasset.com

  

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