The Risks of Investing in Penny Stocks and How to Reduce Them
UPDATED: March 2022
The Risks of Investing in Penny Stocks and How to Reduce Them - Penny stocks can help you achieve major gains in the market. Still, investing can be a little risky.
The Risks of Investing in Penny Stocks and How to Reduce Them
You need to take these risks into account when deciding to invest in penny stocks so that you can make the best investment decision. Here are some of the risks of investing in penny stocks and how to reduce them:
Limited Information
You shouldn't expect much in terms of company information if a penny stock is trading on the OTC, and most likely, it won't be available at all. That means, unlike with other stocks, you can't base your investment decision on any factual information.
Limited Liquidity
The lack of interest from buyers is one of the main reasons why penny stocks are so cheap. That can create liquidity problems for you, since when you are looking to sell these stocks, there may be no one interested in buying them. That makes it impossible for you to get rid of these stocks quickly.
Wide Bid/Ask Spreads
The bid/ask spread of penny stocks will be massive due to their low liquidity. That means you could pay $2.50 for a stock that generally sells for $2.00, meaning you get an instant 20% loss on your investment. That also goes back to the lack of buyers because the spread will be wider if there is a smaller buyer pool.
No Exchange-Imposed Standards
There won't be any oversight unless the penny stock is listed on the Nasdaq or NYSE. The company doesn't need to meet any minimum exchange-imposed standards, which raises the chances of fraudulent activity taking place.
The Potential for Bad News
As there is low interest in penny stocks, if a few sellers start dumping thousands of shares, it would plummet the stock price. A stock may be trading in a healthy position, but it won't take much to see the price plunge. The price can go up in a hurry as well, which means that you have less time to react to any bad news.
The Company Could Go Out of Business
Companies that are dangerously on the edge of solvency generally offer penny stocks. So, if the company you have invested in finally closes its doors, your investment will vanish with it. Most distressed companies may never recover, and most small companies never transition into more prominent companies.
Possible Schemes
It would help if you kept an eye out for fraudulent deals when investing in penny stocks. There may be pump-and-dump schemes, where an individual may claim to have insider information to raise the price. There may be times when a promoter short sells a penny stock at a higher price and then shares negative news to reduce it. Also, watch out for promoters who advise you to buy penny stocks every time the price falls and promises you massive profits as the price increases again.
Conclusion to the Risks of Investing in Penny Stocks and How to Reduce Them
Now that you have learned the risks of investing in penny stocks and how to reduce them, you can profit more from penny stocks. The simple concept to remember is to be aware of the risks and minimized them by using the tips, techniques, and strategies listed above. Keep in mind that penny stock investing is basically the same as stock market investing except that since penny stocks often have lower prices and higher liquidity risks, the rewards can be greater just as the losses can be too.
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