Pros and Cons Of Investing In Penny Stocks

By: Mika Hamilton

Typically when you think of trading stocks, the major stock exchanges may come to mind like the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotations (NASDAQ), and the American Stock Exchange (AMEX). A Penny stock is a low priced security for a very small company with a market capitalization of under $500 million and usually trade in very low volumes. Penny stocks also trade on other "other the counter" exchanges like the OTCBB and Pink Sheets.

Due to the low trading volumes, penny stocks are an investment option that comes with a sizeable amount of risk. According the Securities and Exchange Commission, potential investors in penny stocks should be aware of the fact that due to the low trading volume of these stocks, it is possible that an investor won't find a buyer for their shares. Finding accurate price quotations are also difficult making it a strong possibility that an investor can lose their entire investment.

Penny stocks do carry a certain appeal for many different kinds of investors. Chances are though, a new investor looking for a potentially lucrative investments with a fairly low entry price will run across the penny stock. The allure comes in the fact that at such low prices any changes are often measurable in hundreds of percent in a given day or two. An investor's stock value can literally become worth double or even triple the original investment amount.

Conversely, the price of a penny stock can drop in value just as quickly. New and inexperienced investors would do well to avoid making penny stocks a major part of their investment portfolio. Also due to the low listing requirements on exchanges like OCTBB and Pink Sheets, many companies are not to be considered safe investments. Many of the companies listed on alternative exchanges lack enough financial history to be able to accurately determine if they would make a good investment or not. In some cases, companies that are considered to be penny stocks are either new companies or are in some cases dangerously close to bankruptcy.

Unfortunately, some traders have even taken to artificially manipulating stock prices by buying up large amounts of a stock and then convincing individual investors of the need to buy. Since most of these stocks aren't in such great demand, an investor will have to lower his asking price in order to entice a bidder, oftentimes at a loss.

Not every company that trades for "pennies" should be considered fraudulent. Some are simply small companies trying to grow their business and are working very hard to end up on the larger market exchanges. Wading through the fraudulent companies to find the truly reputable companies capable of helping an investor turn a large profit may not be worth it. Investors with low investment income may be convinced that just one good trade can triple their investment, but in the end an investor is better off choosing an investment from a company that they have researched and are convinced that this company's value will grow in the future.

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