Many traders opt for trading penny stocks to expand their portfolio as part of their overall diversification strategy, but it’s important to understand that investing in these stocks can also be a double-edged sword.
The ease of trading penny stocks is facilitated by the fact that they are less than a dollar. These stocks are not traded at the major stock exchanges, like the NYSE or the NASDAQ.
Many investors have seen lucrative gains off penny stocks, yet there are still some who don’t place much faith in this type of investment. Anyone entering the penny stocks market should be aware of the benefits and losses they can incur in this process.
Advantages of Trading Penny Stocks
Inexpensive to Buy
There are many amateur investors who find trading penny stocks to be quite appealing. This is because of the obvious fact that these stocks are sold at a minimal price.
Therefore, amateurs have a way to invest in the market without facing too much uncertainty or risk because of the amount of money invested is low.
This makes it apparent that if the value of the stock falls, the investor will bare minimum losses.
Easier to Purchase
The way you buy penny stocks is relatively easier than buying conventional stocks. They are bought in the form of common shares, therefore they are easily accessible by the general public. A vast majority of stock exchanges carry penny stocks.
High Potential for Profit
Penny stocks can yield lucrative gains for investors. In several cases, penny stocks can double or even triple in value within a relatively short period of time. Traditional stocks generally take more time to gain value compared to penny stocks.
If invested in wisely, trading penny stocks can be highly profitable as a stock investment option. Investors should look out for newly established companies because their stocks are cheaper to purchase and the potential for growth is very high.
Diversify Your Investments
Any trader is likely to find several profitable opportunities in this market. You can increase your chances of making profits by diversifying your investments. This means that you should purchase several stocks rather than putting all your money in one stock. Every investor should know the adverse risks of putting all their eggs in one basket.
Disadvantages of Trading Penny Stocks
Lack of Regulation
Since companies that offer penny stocks are not governed by the Securities and Exchange Commission, they do not have an extensive business history. Due to the lack of regulation by the SEC, it is not mandatory for these businesses to have audits and send reports of their assets and other vital financial data.
This creates information asymmetry among investors because they are not fully aware of what they are purchasing.
Trading penny stocks can sometimes cause adverse selection because it is very difficult for the investor be completely confident in the longevity of the company. Therefore, as is the case with most investments, there is an inherent risk that the investor faces in terms of profitability. In rare cases, traders get scammed by fake companies.
Cheaper is not Always Better
It is not always a positive aspect that a low investment is a good investment. Since penny stocks are so low in price, this often indicates that the company offering the stocks is going through financial trouble and may even be going bankrupt. However, most investors do hope that the company is eventually able to get back up on its feet and consequentially, cause an increase in the value of the stock. This can be a difficult task for even the most seasoned traders.
Word of mouth is not necessarily a credible source for the confirmation of a good stock. There are some penny stock “experts” that are hired by companies to give positive reviews about their stocks. This can end up as another form of information asymmetry because the buyer is not aware of the credibility of his investment.
Therefore, any investor interested in trading penny stocks should closely analyse these stocks in order to see where the most lucrative gains can be made.