When I first got into stocks, I had funded my Robinhood account with $800 and started to invest. While my smart friend chopper was in all low-risk companies with companies that have no debt, I was investing in penny stocks. My portfolio consisted of 7 penny stocks of random companies I knew nothing about. I quickly gained $150 in profit from some micro-cap company pumping and dumping their stock. From there on, I lost money every single day until I pulled out with a loss of $200. I decided to take a step back and adjust my strategy to a long term approach with good stable companies. I was looking at companies that have no debt and a steady dividend. Penny stocks are mostly a scam, and 1 out of 500 could become profitable. Here are three reasons why you should AVOID penny stocks.
What is a Penny Stock?
A penny stock is a small-cap company that is usually traded at $5 or less. They trade infrequently and lack liquidity. Penny stocks are considered highly speculative because there is not much information on these companies. Most companies that are “Penny Stocks” are on the smaller side and are trying to raise funds for their projects or services through the stock market. Many beginner investors/traders look towards penny stocks because it is viewed as a “get rich quick scheme,” but they really take your money in the end. There are several risks associated with penny stocks that make many investors want to steer clear.
Reason 1- Better off Investing in a Reputable Company
As tempting as it sounds to invest in penny stocks, it is one of the highest risks in investing in the market. Your better off investing in a well established reputable stock like Facebook. Focusing on reputable companies whose financial statements show low debt and good cash flow. This is a better approach to investing in a penny stock that has a ton of debt and doesn’t have much support. Your best chance of making money in the stock market is to invest in quality companies whose roots are deeply engrained in society. You are looking to hold these investments for over ten years. With penny stocks, you are highly unlikely to make money unless you are lucky. But buying a stable, low debt, and strong cash flow company will yield profits for many years to come.
Reason 2- Lack of Information
The key to investing in any company is to learn there a business model to make informed decisions before investing in a company. A problem with penny stocks is often the companies are so small that you can barely find any information on them. Much of the info you see on these stocks are not credible sources and often are company insiders trying to pump there stock to your average uneducated investor. Penny stocks have a high probability of fraud and bankruptcy. This lack of useful information, coupled with the low price of penny stocks, makes them highly volatile. Despite the low trading volume, penny stocks can swing quickly as wrong information comes available to the public.
Reason 3- Lack of Consistency in Performance
Almost all penny stocks have a failure percentage of 100%. Nasdaq requires stocks to stay above $1, and if they don’t stay above that price, they get delisted from the exchange and open up in another type of exchange called OTC, which has fewer restrictions. The majority of investors who take a “shot” at the penny stock game walk away with less money then they did before it started, these stocks are way too volatile and almost impossible to predict.
Huggenberger, Tim. “What Percentage of Penny Stocks FAIL and How Many SUCCEED?” Start Online Trading, 16 Aug. 2019, start-online-trading.com/penny-stock-failure-rate/.
Murphy, Chris B. “How Penny Stocks Trade and How Investors Can Buy Them.” Investopedia, Investopedia, 12 Sept. 2019, http://www.investopedia.com/terms/p/pennystock.asp.