Are Penny Stocks Worth It? Your Guide to The Risks And Rewards Of Penny Stocks

posted by Chris Valentine

Are penny stocks worth it? Stocks under a dollar draw split opinions. Some financial gurus claim they are too risky, but there can be great rewards in store.

Penny stocks are one of the most controversial investment avenues to explore.

The term refers to stocks that trade under $5. They can go as low as a few pennies, hence the name. These low financial barriers to entry and promise of great rewards are a huge magnet for investors.

But, penny stocks have rightfully earned their bad reputation. Apart from price, they have low trading volume and market cap. They are also extremely volatile.

And that’s just the tip of the iceberg.

Market regulation is loose and fraud rife. Trustworthy information is hard to come by. You’re almost expected to make cunning speculative plays.

So, the million dollar question is: Are penny stocks worth it at all?

Well, the answer isn’t cut and dried. Trading them is associated with greater risks, but also immense returns. We present you with a comprehensive assessment you can use to inform your endeavors.

It’s a Risky Business All Right

Trading penny stocks is a gamble at best.

In principle, they work the same as any other security. General stock trading rules apply.

But, unlike blue-chip stocks, their prices fluctuate wildly. Liquidity is low and acquiring credible information quite tricky.

There’s no shortage of scammers preying on novice investors. Some abusive practices we see in the more regulated market run unbridled here. They mostly enrich unscrupulous insiders.

The most common form of market manipulation comes in the form of pump-and-dump schemes.

They involve promoters artificially inflating interest in obscure stocks. Once the demand peaks, they sell or dump at a big profit. Actual investors end up high and dry.

Another ploy to be aware of is short-and-distort.

In a way, it’s the opposite of pump-and-dump. The investor borrows money for shares and sells them immediately. Once the prices fall, this individual purchases the stocks again for a hefty profit.

The list of schemes goes on and includes:

  • Reverse merger
  • Mining scams
  • The Guru scam
  • “No Net Sales” scam
  • Offshore scams

Before venturing further, make sure to get familiar with all of them.

Avoiding the Pitfalls

The good news is you can take active steps to mintage the risks.

Rule number one is to verify your sources of information without exception. For instance, learn the difference between legitimate equity research and promotion.

Ignore overhyped success stories floating around and beware of free penny stock newsletters. They are full of misleading advice, false promises, and suspicious stocks. Their writers often get paid to feature overly flattering reports.

If you see them in the inbox, read the fine print and pay special attention to the “disclosures” section. Sniff out dishonest stock promoters pitching unworthy stocks.

Furthermore, realize penny stock companies bear some inherent risks.

They possess poor market capitalization, have minimum operations, and face constant risk of bankruptcy. Sometimes, it’s hard to predict what is more likely to occur— a spectacular fizzle or success.

The most reliable indicator here is the quality of the company’s management. You need to evaluate the track record of directors and executives. In particular, confirm they didn’t leave a trail of legal and financial disasters.

The next step is to go through the business plan and finances.

You aren’t likely to find in-depth information. But, you should be able to gain access to financial statements. While reviewing them, double-check balance sheets for significant dept or liabilities outstanding.

The more disclosure there is, the better it is. Namely, this is a telltale sign of corporate transparency and credibility.

Level of disclosure is also one of the factors OTC Market Groups takes into account. The other two are investor engagement and integrity of operations.

Playing it Smart

Even when armed with caution and vigilance, most investment tactics remain risk-laced.

So, take some extra precautions to protect yourself.  For example, one neat trick is to limit your holdings to up to 2% of your portfolio. That way, you can cap your losses and prevent a complete train wreck.

Secondly, diversify your overall portfolio. It’s not advisable to have penny stocks accounting for more than 10%. Some experts claim 5% is the sweet spot.

Thirdly, setting a stop-loss order with the brokerage is a good idea. It entails automatically selling a stock once it sinks to a certain price.

When it comes to brokerages, you need to pick your online platform wisely. Those that offer penny stocks are few and far in between. Respectable exchanges avoid them like plague.

Thus, like it or not, you have to rely on over-the-counter providers.

Two major hubs are Pink Sheets and FINRA’s OTC Bulletin Board (OTCBB). There are no minimum standards for operating on these exchanges. On the former, companies aren’t even obliged to file under Securities and Exchange.

Fortunately, there’re some reputable websites that feature best stocks under 1 dollar.  They can help you spot stocks that are about to blow up.

Chasing Elusive Spoils

The reason why people pursue penny stocks is a huge potential for short-term rewards.

The basic idea is simple. You discover stocks with the biggest upside potential and sell them for profit. Here, you need to keep an eye on stocks with earnings breakout and make 52-week highs.

They tend to be the best of the bunch.

On the other hand, ignore those that seem like a mere flavor-of-the-day fad. Quality stocks always have ample liquidity and high trading volume. They aren’t just profits on paper but translate into real cash.

Alas, there’s one problem with capitalizing on penny stocks.

In general, penny stock investment isn’t your typical buy-and-hold, long-term strategy. You have to take any profits you can as soon as possible and move on.

The chief issue is you may struggle to find buyers fast. The market is relatively small and most investors spend most of their days selling bits and pieces.  Lowering the price speeds up the process, but drawbacks are self-evident.

So, at the end of the day, this type of security is an unreliable source of passive income. More often than not, risks outweigh the spoils. You are better off creating something like a diversified, low-cost index fund.

But, this isn’t to say penny stocks are a red herring.  Individuals like Timothy Sykes, although quite rare, made a fortune trading them.

Ultimately, it all depends on your risk tolerance. That and the ability not to be on the wrong side of the trade.

Are Penny Stocks Worth It: The Verdict

Penny stock market is fraught with danger.

The best way to approach (if at all) is with the utmost caution. Due diligence and thorough research are paramount.

In other words, assess the quantity and quality of available information. Learn to recognize scams and dubious promotions. Shield against budget-sinking failures and sellers of hype.

Rather than acting on emotions, make educated decisions. Stick to legit companies with strong leadership and rock-solid track record. Invest only the money you can afford to lose.

Feel free to contact us if you need financial advice on your portfolio. And in case you are still left wondering are penny stocks worth it or not, let’s give you a final answer. They are probably not!

But, you know what they say: Nothing ventured, nothing gained.

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