Penny stocks are companies with very small market cap. Generally speaking, penny stocks are companies with a market cap of less than 300 million dollars.
We all know that investing in shares of a stock means you are owning a small percentage stakes of companies such as Apple, which has a market cap of 900 billion dollars.
What is a market cap?
Market cap refers to the total dollar value of a company’s outstanding shares and it’s used by investors to determine a company’s size.
Definitions of what are penny stock may vary but the Securities exchange commission (SEC) classifies penny stocks as companies traded under 5 dollars and many of them, if maintained above 1 dollar are still traded on the NASDAQ or the NYSE, the more regulated stock exchanges.
However the true penny stock are traded under 1 dollar.
These are what we call Pink Sheet stocks, which are the companies which are the companies Jordan Belfort pumped up in the movie, the Wolf of the Wall Street. They are traded over OTCBB, over the counter bulletin boards.
Why Penny stocks are considered Risky investments?
The first and foremost reason is the lack of information available to the public. This really only applies to the OTC penny stocks traded under 1 $. Companies listed on the pink sheets are not regulated by SEC and are not required to make financial documents available to their investors.
So without these documentations, investors cannot find out their cash flow, operating expenses and whether or not these companies are actually gaining revenue. As for the small cap penny stocks trading above 1 dollar and are listed on the NASDAQ and NYSE, these companies are required by the SEC to file their financial statements, register for offerings and inform investors of important updates.
So in that sense, the penny stocks above 1 dollar are little less risky than the true penny stocks on the OTC.
However, they are still sketchy and easily manipulated through misinformation and pump and dumps.
This is the reason penny stocks of all prices are considered risky, many of these penny stocks companies release news and pay promoters to pump their share prices up with sensational headlines.
These penny stock PR often include keywords in titles such as agreements, contracts, strategic placements etc. etc.
These are what they call sensational keywords. Because these sketchy penny companies take advantage of the fact that the most investors and traders in the market are lazy and they do not read past the headlines. Mostly these headlines have fluffy content and they contain no real promises in the company’s potential earnings. The purpose of these PR pumps is to drive up to share prices up to hundred percent.
As the shares hike up, the insider of these penny stock companies start to sell and dump millions of their own shares on unsuspecting investors.
Sometimes these penny stock companies will take advantage of the pumped up share prices to issue offerings and raise more money for their companies.
These penny stock companies recruit third party online promoters to send out promotional emails and publish false and misleading articles.
While many people would argue that the penny stocks on the NASDAQ are more regulated and less risky than the OTC penny stocks.
The reality is these sensational press releases are what’s considered “legal” pump and dumps.
And we are now trading in the grey area now. It is indeed legal, in the eyes of the SEC to release exciting news about the company to the investors.
In the past there has been some extreme NASDAQ penny stocks manipulation cases like LFIN and HUNT, both of these companies released misleading news to drive their share prices up from under 10 dollars to around 100 dollars. So those are basically a 1000% ROI scheme.
Both of these companies were investigated by the SEC and delisted from the NASDAQ stock exchange to OTCBB.
But let’s be real here, these two companies being delisted only represent less than 1% of all the penny stock pump and dump schemes in the market.
Now unless its insider trading or manipulation like LFIN and HUNT stock, these PR pump and dumps from penny stock companies are really just everyday activities in the stock market.
So I want to say that Penny stocks are inherently risky investments. It’s safer to always be skeptical of penny stock promotions, PR releases and penny stock chat room recommendations.
Always remember to do your own due diligence in the company. While I do think some penny stocks can provide great profit opportunities for a day trading and swing trading. People should avoid investing in penny stocks all together unless you have real inside information about the company.
Two very common misconceptions about penny stock’s is that many of today’s big companies like Apple and Amazon were once penny stock themselves, and that if an investor can buy into the investment at twenty cents per share today, then he or she can make a 100% ROI if the stock runs for 40% percent tomorrow. Both of these misconceptions are not 100% true at all.
We must remember the single purpose why private companies choose to go public.
Companies go public and sell their stock shares to investors in order to raise money, to fund their research and potentially develop products to sell.
Stocks are not listed to make investor’s money that’s not the priority anyways, they are there to move capital from your pockets to the companies’ bank accounts.
And if the companies are truly profitable and legit, such as Apple then their stocks will rise in prices and make investors’ money.
That is only true for profitable companies with real products like apple.
The reality is that most penny stocks are actually losing money and do not have real products to sell instead they keep on selling their shares to investors and raise cash to operate to potentially pay their board members until one day they go bankrupt.
In those unfortunate cases the penny stock investors lose their 100% of their investments and the insiders will walk away with clean salaries and bonuses, paid by the investor’s money of course.
While it is true that the price fluctuations of some penny stocks from twenty cents today to forty cents tomorrow could potentially make 100% ROI, what most people fail to see the downside as well. The price of the penny stock could easily drop down to five cents tomorrow in which the investor would lose 75% of their money in just two days.
And very often when these penny stocks get delisted from the NASDAQ exchange to OTC then their share prices just keep on dropping due to offerings, dilutions etc.
It’s not uncommon to see these penny stocks get delisted from the NASDAQ to OTC in which the investor could potentially lose everything!
On the other side, once a while there are penny stock companies on the OTC that have worked very hard and showed impressive growth and finally met the requirements to make their stocks available to the NASDAQ.
A perfect example of that is a marijuana stock called Aurora Cannabis, ACB. Their stock shares listed on the OTC pink sheets as ACBFF, until October of 2018.
However the chances of most penny stocks growing their business to be like Aurora Cannabis is extremely low.
So instead of investing your hard earned money into penny stocks, I think the wiser long term decision would be to invest in established companies like Apple, Facebook etc.
Sure you may not be able to buy as many shares as if you were to buy in penny stock trading under a dollar, but the long term percentage growth on established companies is undeniable.
These investments are much safer as well. I know there is definitely a lot of money in penny stock day trading and swing trading
Investing and trading any kind of securities involves risk. Before throwing your money into any penny stock make sure to do your own research and establish your own risk reward profile.
Always be skeptical of PR releases and do not follow other’s alerts.
This article was not inform you to buy or sell a particular stock but to inform you the potential risk involved with the penny stocks as well as the upside if you day trade or swing trade them correctly.
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Caitlin has done her Masters’ in finance. She loves to write about finance, money making and on tech that would affect us in near future. When she is not writing in her favorite coffee shop, Caitlin spends most of her time reading, cooking, traveling the world, visiting Walt Disney World, and catching her favorite Broadway shows. If you want to know more about her, do follow her on Twitter. Just click on the Twitter icon in this box.