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Penny Stocks – Finding Risk And Reward

Penny stocks.....maybe just reading that phrase sounds the alarm of every stock buying tip you’ve ever received. They are risky, you can lose a fortune and they are merely scams to take your money. No matter what the complaint, many people are strongly opposed to investing in these shares and the companies that they represent. Yet a simple Google search will find you millions of hits on the phrase “penny stocks” and almost everyone knows someone who has either lost or made a bundle chasing the “next hot stock” in the penny stock world. With all of the interest, what is the fear, or fascination, with penny stocks?

A Definition of Penny Stocks
The best definition for penny stocks in the stock market comes from the Securities and Exchange Commission. According to the SEC, the term "penny stock" generally refers to low-priced (below $5), speculative securities of very small companies. To quote the SEC: "Penny stocks generally have market caps under $500M and are considered extremely speculative, particularly those that trade on low volumes over the counter. The Securities and Exchange Commission goes on to warn that, "Penny stocks may trade infrequently, which means that it may be difficult to sell penny stock shares once you own them. Because it may be difficult to find quotations for certain penny stocks, they may be impossible to accurately price. Investors in these stocks should be prepared for the possibility that they may lose their whole investment." This is not, nor ever will be, something a senior citizen wants to do with there retirement investing nor an investment for the causal investor.

Now you can see the fear factor but what is the attraction that can even draw in successful traders? For many people, penny stocks are Las Vegas, the lottery and the pot of gold at the end of the rainbow all rolled into one. For every average guy (or girl) that can’t buy Google stock at $500 or more per share, there are millions that can buy 5,000 shares of MEW Industries at $0.15 per share. Is MEW Industries going to make money? What do they make? Will they even still be in business tomorrow? Like plunking $3 into a slot machine or buying that lottery ticket with all of your favorite numbers, penny stocks give everyone the chance to make it big. The opportunity to turn your 5,000 shares of MEW Industries from a $0.15 stock to a $100 is just to appealing to most people as finding their way to the nearest casino.

The Risks Of Penny Stocks
Quite simply, the ultimate risk with penny stocks is that you can lose your entire investment; that statement right there should wake you up a bit! The risk to reward ratio for these stocks shows that while the possibility of great reward is there, the risk is very great as well. Lack of information to perform technical analysis, financial instability of the companies and scam artists all make penny stocks a virtual minefield of investing. Remember that after its fall from grace, WorldCom actually traded as a penny stock for a while and people actually bought it! In addition, using tricks like the “pump and dump,” unscrupulous traders with try to falsely lure investors with promises of a tremendous growth in a stock at which time they dump their shares for a large profit and leave the other investors holding the bag.

The key to investing in penny stocks
If you want to take a shot at it investing in penny stocks, caution has to be your rule.  First, don’t invest more than you can comfortably afford to lose and that doesn’t mean emptying your account with your broker! Select a reasonable amount as your risk premium. Second, make sure your trading plan is up to date and reflects the dangers of this type of investing.  Finally, learn before you invest! This is always true but more so when you are dealing with a marginal form of investing. Find companies that you can actually research and you will do much better.

Conclusion
Penny stocks are not for everyone. As appealing as they might be, the risks involved require that an investor dig into the data to protect him or herself from the associated stock volatility. So do your research, chart your targets, rub your lucky rabbit’s foot and proceed with caution!  Penny stocks can take you on a very exciting ride!

 

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