How penny stocks are traded and why they are so risky for investors | News

Penny stocks are small companies whose shares are traded for a relatively low price and often in small volume. They are considered speculative investments and can be highly volatile, appealing to traders seeking outrageous returns. However, the losses can be just as great.

But not all penny stocks are created equal, and one factor that sets them apart is where they trade.

How are penny stocks traded?

According to the U.S. Securities Exchange Commission (SEC), penny stocks are shares of stocks that trade for less than $5. Some of these companies are new to the market, may not have complete financial records, or have a solid product, service, or revenue stream. . In certain cases, some of them may even go through bankruptcy filings.

Companies with all their documents in order can list on major exchanges such as the NYSE or NASDAQ, which have strict regulations, such as regularly disclosing financial statements with the SEC.

Since most penny stock issuers are not eligible to list on a major exchange, their shares are traded over-the-counter (OTC) through the OTC Bulletin Board (OTCBB), an electronic trading service operated by the Financial Industry. Regulatory Authority, or through the private Pink Sheets Marketplace.

For the penny stock issuers who file financial statements with the SEC, their ticker symbols begin with an OB suffix on the OTCBB. For penny stocks traded on the Pink Sheets platform, their ticker symbols have a PK suffix.

For retail investors, it is important to note that over-the-counter trading takes place between parties outside a major stock exchange and without the supervision of a stock market regulator or a market maker to ensure the liquidity of the shares.

The lack of a stricter listing process and low liquidity, for example, open the door to numerous risks, such as possible market manipulation.

What other factors make penny stocks risky?

Investors often rely on publicly available information to assess a potential investment opportunity. This information can come from reputable news outlets, a broker investigation team, SEC filings, and so on. However, these materials can be difficult for small businesses to find and may not always come from reliable sources.

Since some of the penny stock issuers are newly established, historical data is unlikely to be available, making it challenging for investors to assess current and future valuations.

Likewise, not all pennystock companies are required to disclose financial statements. As a result, these companies may not receive the same level of investor scrutiny as more established names such as blue-chip stocks. Pink Sheet stocks are considered the riskiest because issuers are not required to disclose financial information.

Low trading volumes also provide opportunities for savvy traders to take advantage of volatility that often drives penny stock prices artificially higher (or sometimes lower).

For example, in a pump-and-dump scheme, traders will incentivize investors to get in on the next hot stock, causing the stock price to rise rapidly as buy orders come in. But when investors come to their senses and realize the high prices are likely unwarranted, those stocks often crash, leaving those who bought at high levels holding the pocket.

Are penny stocks a good investment?

For small businesses, making their stock public helps them access public funding, which can be their lifeline as they try to grow. And for investors, it can be lucrative to support the businesses that succeed, especially if those products or services really take off.

Of course, for investors, identifying a winner in a sea of ​​penny stocks can be seen as finding a needle in a haystack.

When it comes to penny stocks, the allure for traders is the potential to earn significant returns from small amounts of capital. So while a large stock like Apple typically trades within 2 percent margin over the course of a day or week, a penny stock can see its shares move north of 10 percent or more in either direction for one day.

Due to the added volatility and low stock price, many penny stock traders see it as an opportunity to make a quick profit. And to mitigate the risk associated with over-the-counter companies, they go after penny stocks listed on major exchanges like the NYSE.

There are plenty of strategies for trading penny stocks. But as with any investment, it’s always wise to do your homework, review financial records, start small, and avoid letting greed or fear influence your decision-making.

(Visit Bankrate online at bankrate.com.)

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