Do Low Priced Stocks Mean Low Risks for Penny Stock Investors?

Contributed by OTCPicks.com

Many people who are new stock trading think that penny stocks are the obvious and logical choice. The word penny indicates that the investment is small enough that they won’t have to risk a lot for a great deal of potential.

Many people who are new stock trading think that penny stocks are the obvious and logical choice. The word penny indicates that the investment is small enough that they won’t have to risk a lot for a great deal of potential.

The truth is that all investors need to understand that while penny stocks may not cost a lot per share and you seem to be able to buy a lot of shares for minimal cash, it could cost you more if the company’s stock that you are trading goes away. Many companies at this stage of their corporate development need cash and capital. Many of these small public companies use their stock as equity in raising operating capital by various means, and some don’t get the funding they need or don’t turn the corner on profitability before their funding resources run out and simply cannot continue as a “going concern” and have to shut down their businesses.

Penny stock investing, just like any other investment opportunity, requires the trader to look carefully at the company’s financial history and expected future earnings as well, if you can find it though SEC filings.
Brokerage firms that help penny stock investors trade in this type of transaction, are required to disclose the risks using a document that tells the customer exactly what the risks are before they choose to hand over their money.

Penny stocks, unlike other kinds of higher-priced stocks, aren’t traded as often, so one of the larger risks involves being stuck with penny stocks once you own them. And since they’re not traded often, the pricing you’re seeing can be inaccurate or out of date.

The term used to describe the degree of trading volume and activity is liquidity.

Liquidity is defined as:
The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity.

 The ability to convert an asset to cash quickly.

So, liquidity is an important factor in trading penny stocks. Typically there are sellers there waiting to accept your offer so you can buy stock in a company. The trick is being able to sell it when, and at what price, you want for it. If a stock is not liquid and has minimal trading volume, you may be stuck with the stock not being able to trade it if the stock price starts to fall, or not being able to trade or sell it when it appears to be at a price you want to sell at. Typically, the more consistent trading volume there is in a stock, the safer it will be to trade, at least in so far as readily being able to buy and sell a stock on a consistent basis.

Perhaps the biggest risk in investing with penny stocks is the mere hype that goes along with it. There is a lot of spam associated with many penny stocks that we all receive each day. There are also reputable and some disreputable IR companies out there promoting micro cap stocks. Many of these companies can be a good resource for more information on micro cap and penny stocks, but look beyond the hype and dig into the facts via your own research and base your decisions on all of the information you come up with.