Penny stocks are considered high-risk investments. Investors often look to invest a few hundred dollars in a penny stock and watch it shoot to a few thousand dollars. This occasionally happens but this is not the norm. When investing in low-priced stocks, it is important to use the same due diligence needed on all security investments. There are, however, a few considerations that especially pertain to penny stocks.
Penny stocks are traded on all stock exchanges. The major exchanges, such as the NYSE, NASDAQ, AMEX have reporting requirements that make it easy to see clearly what the stock is doing, its financial condition, and much other valuable information that will help you make an informed decision. Stocks that are traded over-the-counter may not have as much information available to the investor. For some, there is little or no information available and the information you do get may not be reliable since there are few if any regulations to abide by.
Penny stocks may not be liquid. You may have to pay more or accept less to buy or sell your stocks quickly. Some penny stocks are classified as micro-cap stocks. Because there are fewer buyers and sellers, especially in the OTC markets, micro-cap penny stocks are not as liquid as mid-cap and large-cap stocks. When it comes to capitalization, smaller is more volatile. A small float will move more quickly. It may jump up or down quickly after a news event. Higher volume is better. Look for stocks with good liquidity.
Thinly traded penny stocks can be vulnerable to easy manipulation in order to drive their prices up. These artificially inflated stocks are perpetrated by scammers who make money tricking unaware investors into buying these worthless stocks. The term for this type of trickery is “Pump and Dump.” First, they pump up the price by buying large volumes of the stock. Next, they advertise and market the stock, and finally, they sell their stocks into the buying frenzy. After they have emptied their portfolios of this hyped-up stock they disappear. The buyers are left holding stocks that no one else wants, so the price drops dramatically, causing big losses to the buyers.
Price Movement Drivers
For penny stocks that lack liquidity, a stock buyback by the company can start a rally. By removing shares they decrease the float. A lower float will result in a faster price movement.
Legislation regarding such things as food, drugs, tariffs, and energy production can change a stock’s prospects instantly. It is important to follow industry news to find new opportunities, as well as avoid those industries that will be more regulated, banned, or replaced by newer technology.
Some industries are heavily dependant on commodities.