As we all know, a penny saved is a penny earned. However, if we have a look at the penny stocks and their volatility, a penny invested may easily be a dollar gained or vice versa. If you are not cautious enough, the low cost of these stocks can easily tempt you to buy more and more of them; such are their returns if you are lucky!
In general, a penny stock is a stock with a value of $5.00 or less per share. They are not traded on the regular stock exchanges like the New York Stock Exchange (NYSE). Instead, penny stocks are traded on over-the-counter markets through the use of electronic quotation systems called “pink sheets.” Smaller start-up companies with less than $4 million in assets or that do not own tangible assets like buildings and equipment are more likely to issue penny stocks than larger corporations.
Unlike regular stocks where share prices are easily found in a newspaper or online, determining the buying or selling price of a penny stock is a bit more complicated. In a typical transaction, your broker-dealer, also known as an agent, arranges a trade for you based on the bid price, which is the amount someone is willing to pay for a stock, and the ask price, which is the amount for which someone is willing to sell a stock. The difference between the two is known as the spread, which will determine how much money you make or lose on a trade. Hence choosing the right brokerage is of utmost importance while investing in Penny Stocks.
Profitability and Risk
Factors like the complexity of transactions, the fact that penny stocks are often issued by start-up companies and the fact that broker-dealer commissions are based on the size of the spread, may require you to pay close attention if you were to make good profits. The nature of penny stocks normally attracts investors who want to get in and out of the market quickly, with the hope of making nice profits in less time.
One thing to note in penny stocks is that the market is subject to a high level of price manipulation by broker-dealers. In some cases, their actions can even force companies to go out of business. Unlike typical stock transactions where your broker-dealer makes trades on your behalf, a penny stock broker-dealer can also make trades to benefit themselves, meaning they may not necessarily be looking out for your best interests. Hence, choosing a stock broker-dealer for these kinds of investments is extremely important.