Due to the nature of penny stocks and how do they work, the make-up of the penny stock market can differ from that of regular stocks. With small market capitalizations and lower prices per share, the way this market moves and the companies associated with this market can be rather distinct.
What is the penny stock market?
The penny stock market is made up of mostly speculative, cheap securities, that exist with volatile conditions. Although some penny stocks trade on major exchanges like the NASDAQ and NYSE, penny stocks are often found trading on pink sheets or over-the counter and have no minimum standards to fulfill.
The companies can be newly formed, have just released an initial public offering (IPO), or are at the later stages of their life cycle and nearing bankruptcy. While there are many former large companies that may find themselves on a penny stock list, it is more common to find pharmaceutical companies claiming to have developed the next big drug ready for international distribution but awaiting FDA approval. Because of this, the penny share market is highly information sensitive and consequently is highly volatile. A lack of fundamental information on penny stock companies creates more speculative purchases and leading to some regarding these trades as gambles
Is the penny stock market for me?
The penny stock market is definitely not for everyone. Before being attracted to the success stories of people making massive returns off penny stocks, it is extremely important to understand the risks involved. It is crucial to ensure that penny stocks fit into your overall investment strategy before investing in them.
Like any investment, the risk and return of these investments are correlated. Although there is the potential for big gains, there is often an even greater chance of massive losses. The low liquidity associated with these stocks increases the chances of having difficulty finding a buyer for your shares and this can be extremely painful when the share price is dropping. If you already have a well diversified portfolio, have a little cash that you want to take more risk with and are ok losing, then penny stocks may be right for you. It is important to know what kind of investor you are. Understanding your risk tolerance is a key first step to finding out. Learn more about building your portfolio with Wall Street Survivor's Building Your Portfolio course pack. Want to know if you are a risk taker? Take this quiz and find out!
5 Things To Know Before Trading Penny Stocks
Do your research
The more research the better. Although there is minimal information available on the actual companies, the more of it you are actually able to gather, the sounder your investment decision will be. Avoid purchasing a penny stock just because it was recommended to you online. You may become victim of the price manipulators that are so common in this industry.
They move on momentum
Look for price patterns amongst these stocks. They generally head in certain directions for a period of time before experiencing a reversal.
Set proper expectations
Don't purchase penny stocks with the hopes of hitting a home run because chances are you won't. Take your profits when you can and don't get too greedy. These stocks can change directions rather quickly.
Don't bet the house
Assess the consequential outcome if you loose your entire investment in a short period of time. If it leaves you in a strenuous position, look for a safer investment.
Trading halts may occur
If the price of a penny stock spikes up to fast, it may be halted by the SEC for further investigation. This can be a problem because the price of the stock may continue to rise or fall while halted leaving the investors with no control and vulnerable to potential significant losses.
Being aware of the differences between is the penny stock market and the regular stock market is great, but it doesn't stop there. Finding the right stocks to purchase is (obviously) the most difficult part. It is common for investors to not even know where to start when looking for penny stocks. Read on how to find penny stocks and most importantly, how to avoid being the victim of a penny stock scam.