Penny Stocks

Penny stocks are often enticing to new investors. But should they be? Learn more.

The term “penny stock” generally refers to a security issued by a very small company that trades at less than $5 per share. Penny stocks generally are quoted over-the-counter, such as on the OTC Bulletin Board (which is a facility of FINRA) or OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.); penny stocks may, however, also trade on securities exchanges, including foreign securities exchanges. In addition, the definition of penny stock can include the securities of certain private companies with no active trading market.

Be aware of the downsides of purchasing penny stocks. Determine if penny stocks fit your investing strategy as penny stocks are inherently a “high risk, high reward” venture. Never invest more than you are willing to lose.

Penny stocks are not very liquid and the company’s weak market position and fragile financials make them risky investments, subject to total loss. Investors in penny stocks should be prepared for the possibility they may lose their entire investment. Penny stocks also trade infrequently, so it may be difficult to sell penny stock shares once you own them. The prospect of outsized returns should be balanced against these risks.

Even with these clear dangers, some people insist on trading the pennies. If you must, Marketwatch suggests 10 rules to avoid dangerous penny stocks:

1. Ignore penny-stock success stories
2. Disregard tips and read the disclaimers in penny stock emails and newsletters
3. Sell quickly
4. Never listen to company management
5. Don’t sell short
6. Focus only on penny stocks with high volume
7. Use mental stops
8. Buy the best of the bunch
9. Don’t trade large positions
10. Don’t fall in love with a stock

Sure, it’s possible to profit when you understand the game, but the odds are against you when you don’t. And worse: manipulators and scammers often run the penny-stock game. Penny stocks have probably earned their bad reputation, so beware.