Buying penny stocks can be fraught with pitfalls for a novice penny stock investor. Here are a few things to know about this type of investment tool before you start to buy them. A penny stock is also known as a micro cap stock because of the amount of capitalization invested in the company, usually between $50 million and $300 million dollars. The term penny stock is a bit of a misnomer too. According to the SEC, any stock under $5.00 is a penny stock, but other definitions lower than that includes $3.00 a stock or even $1.00 a stock. The main thing to know that they are a riskier investment than regular stocks.
What is lacking about these types of stocks is any credible information or documentation to make an informed decision. Any company listed on the over the counter bulletin board or pink lists is not always required to provide any information with the SEC so documentation is not always believable. While the OTCBB requires its micro cap companies to file documentation, there is no similar requirement by the pink lists for their companies to do the same.
Lack of information about a micro cap stock company indicates one of two things: it is either a new company or one near bankruptcy. The lack of historical information makes it difficult to assess whether or not the stock is a good investment.
Low liquidity of micro cap stocks is another potential pitfall. When the stocks do not have a lot of liquidity, investors may have trouble selling them. To make these types of stocks attractive, the investor may be forced to lower the price below what they paid for them. Secondly, low liquidity may leave the investor vulnerable to a phenomenon such as pump and dump where traders buy large amounts of a particular penny stock, hype it to the point where investors find it attractive and then sell it to take advantage of the hype.
Penny stocks can be a baited trap because some micro cap companies pay individuals to recommend the company stock in the media such as newsletters, radio shows and financial television. Check to see if these people are being paid for their recommendations of a particular stock. This is usually a dead giveaway of a bad investment.
Overseas brokers are another sign of a potential risk for penny stock investors. Since the SEC allows the selling of stocks to off shore or overseas brokers, foreign investors are not required to register the stock that they buy. What they then do is resell the stock back to US brokers at inflated prices, making significant profits in the process.
Many new companies work very hard to get on the main stock exchanges and do represent a good value for the investor. Make sure buy penny stocks right, by doing the research online at forums, bulletin boards, newsletters and news sites. Here are some of other things to do before you buy.
Speak to a number of online discount brokers. Visit their websites to educate yourself on their fees, commissions and reliability of their services. Fund your trading account with an online stockbroker.
Research the micro cap company before you buy the penny stocks. Understand their business, liquidity and management. Monitor several times a day the price of the stock in your portfolio. These stocks are extremely volatile and you can take a huge loss very quickly.
Buying penny stocks will always be a high risk investment strategy because they are usually from new companies with little history. But with careful planning and doing your research, you will find them a rewarding and exciting experience.
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