Best Stocks To Buy Into For Beginners – A penny stock usually refers to the stock of a small company that trades for less than $5 per share. Although some penny stocks trade on major exchanges such as the New York Stock Exchange (NYSE), most trade through over-the-counter (OTC) transactions through the electronic OTC Bulletin Board (OTCBB) or through the privately owned OTC Markets Group.
In the past, penny stocks were considered any stocks that traded for less than a dollar per share. The U.S. Securities and Exchange Commission (SEC) changed the definition to include all shares trading under five dollars. The SEC is an independent government agency responsible for protecting investors by maintaining the proper and orderly functioning of these securities markets.
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Penny stocks are usually associated with small companies that have a lack of liquidity, which means there are few willing buyers in the market. As a result, investors may find it difficult to sell the stock because there are not enough buyers. Due to low liquidity, investors may struggle to find a price that accurately reflects the market.
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Because of their lack of liquidity, wide bid-ask spreads or price quotes, and small company sizes, penny stocks are generally considered highly speculative. In other words, investors may lose a large amount or all of their investment.
Penny stocks often represent growing companies with limited cash and resources. Because these are primarily small companies, penny stocks are best suited for investors with a high risk tolerance.
Generally, penny stocks have a higher level of volatility, resulting in a higher potential for reward and, thus, a higher level of inherent risk. Investors can lose their entire investment in a penny stock, or more than their investment if they buy on margin, which means the investor borrows funds from a bank or broker to buy the parts.
Investors should consider the increased risks associated with penny stocks. For example, an investor should have a stop-loss order set in advance before entering a trade and know what price level to exit if the market moves against them. Stop loss orders set a price limit that, once reached, triggers an automatic sale of securities.
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Although penny stocks can have explosive gains, it is important to have realistic expectations and understand that penny stocks are high-risk investments with low trading volume.
Because of their low volume, penny stocks tend to be more volatile than established equities. This means high opportunities for gains and losses, and investors should be careful to understand the risks and benefits.
Penny stocks give some small businesses a way to access funding from the public. These companies can use this platform as a starting block to move into a larger market.
Also, since they are selling at such a low price, there is room for significant upside. Some companies, such as Amazon (AMZN) originated as penny stocks but later grew into major blue-chip companies.
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A blue chip is a recognized, well-established, and financially sound company. Blue chips typically sell high-quality, widely accepted products and services. Blue-chip companies often have a history of weathering downturns and operating profitably in the face of adverse economic conditions, which helps contribute to their long record of stable and reliable growth.
However, certain factors exacerbate the risk associated with investing in or trading penny stocks. These securities are often riskier than those of more established companies.
When considering options for potential investment, it is important to have enough information to make an informed decision. For some penny stocks, corporate performance information can be very difficult to find. If this is the case, the information available about them may not come from reliable sources.
Stocks traded on the OTCBB carry the “OB” suffix on their symbol. These companies file financial statements with the SEC. However, companies listed on the pink sheets are not required to file with the SEC. As such these businesses do not receive the same public scrutiny or regulation as stocks represented on the NYSE, Nasdaq, and other markets.
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OTCBB stocks and pink sheets do not have to meet minimum standard requirements to remain available for trading through OTC exchanges. In the event that a company is no longer able to maintain its listing position on one of the major exchanges, the company may move to one of the smaller exchanges to list on the OTC. Minimum standards can act as a safety cushion for some investors. If a company is not subject to higher standards, investing in that company becomes more risky.
Many of the companies considered penny stocks may be newly formed, and some may be on the verge of bankruptcy. These companies often have poor track records or no track record at all. As you can imagine, this lack of historical information makes it difficult to determine a stock’s potential.
Stocks that trade infrequently don’t have much liquidity. As a result, it is possible that investors will not be able to sell the stock once it is acquired. Investors may need to lower their price until it is considered attractive to another buyer.
Low levels of liquidity also provide opportunities for some traders to manipulate stock prices. A pump and dump scheme is a popular trading scam to lure investors into buying stock. A large amount of a penny stock is bought followed by a period when the stock is raised or pumped.
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Once other investors rush to buy the stock, the scammers sell their shares. When the market realizes that there is no fundamental reason for the stock to rise, investors rush to sell and may take huge losses.
While penny stocks are volatile, there are some precautions an investor can take to reduce their risk. One is to conduct due diligence: Because penny stocks tend to trade in areas with low entry requirements, investors should be careful to read company statements and make sure that the company is doing well financially.
It is also important to trust reputable stockbrokers. While there are scams to watch out for, most of them are promoted by suspicious emails and cold calls. A reputable broker should be able to provide high quality written research to back up any investment claim.
Finally, as with any speculative investment, don’t put in more money than you can afford to lose. While you can make money day trading, returns are more consistent in established, large equities.
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Despite the risks, penny stocks can be profitable for a cautious or thorough investor. The key is to avoid some mistakes that are common in speculative investments, such as believing that they have an opportunity to make a profit. Even if this is true, they both score a lot of losses.
Another important mistake to avoid is the underpricing fallacy, which holds that lower-priced securities are inherently “cheaper” than higher-priced securities. However, it does not account for factors such as market capitalization or liquidity. Even if a stock doubles in price, it may be impossible to sell many stocks without the price slipping significantly.
Although there is no foolproof method to determine which penny stocks are fraudulent, the SEC recommends that investors heed the following warning signs in a company’s record: SEC trading suspensions, large assets but small revenues, financial statements with unusual items in the footnotes, strange audit issues, and large owner ownership.
California resident Zirk de Maison created nearly half a dozen shell companies and offered them as penny stocks to investors between 2008 and 2013, according to the Federal Bureau of Investigation (FBI) .
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De Maison told investors that the companies were engaged in various businesses, such as gold mining and diamond trading when, in fact, they did nothing. He sold stocks in “boiler rooms,” offices where brokers used high-pressure tactics to push people to buy stocks by promising huge profits.
Small companies and startups often issue stock as a way to raise capital to grow the business. Although the process is long, issuing stock is often one of the easiest and most effective ways for a startup company to raise capital.
A penny stock, like any other publicly traded stock, is created through a process called an initial public offering or IPO. To be listed on the OTCBB the company must first file a registration statement with the SEC or file stating that the offering qualifies for an exemption from registration. It should also check the securities laws of the states in the locations it plans to sell the stock. Once approved, the company can begin the process of soliciting orders from investors.
Finally, the company can apply to list the stock on a larger exchange, or it can be sold on the over-the-counter market.
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As with other new offerings, the first step is to hire an underwriter, usually a lawyer or investment bank that specializes in securities offerings. The company’s offering must be registered with the SEC, in accordance with Regulation A of the Securities Act of 1933, or file under Regulation Dif exempt. If the company is required to register, Form 1-A, the registration statement, must be filed with the SEC along with the company’s financial statements and proposed sale.
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