What are Penny Stocks? Opportunities and risks of the cheap stocks

What are penny stocks

What are Penny Stocks – Penny stocks were originally stocks that traded for less than one U.S. dollar per share. However, according to the new definition of the U.S. Securities and Exchange Commission (SEC), all stocks that trade for less than 5 U.S. dollars fall under this term.

Penny stocks are usually associated with small companies. They often have a lack of liquidity or ready buyers in the market. Due to the low liquidity, it can sometimes be difficult for investors to find a price that accurately reflects the market.

For this reason, the large bid-ask spreads or price quotations and the small size of the company, penny stocks are generally considered highly speculative. Investors can therefore lose a considerable amount or their entire investment. On the other hand, of course, the opposite price development is tempting, which can also turn out extremely (positive) with the inexpensive penny stocks.

Table of contents

What are penny stocks?

 

Penny stocks are typically shares of small companies that trade for less than $5 per stock. Most penny stocks are traded over-the-counter (OTC) through the electronic OTC Bulletin Board (OTCBB) or through the privately held OTC Markets Group. However, some of the low-cost securities also trade on major exchanges, such as the New York Stock Exchange (NYSE).

What makes penny stocks risky?

Penny stocks can be a way for small companies to access funding from the public. They then usually use this platform as a basis to enter a larger market.

In addition, since the price per share is initially very low, there is room for significant upside potential. However, some other factors increase the risk associated with investing in and trading penny stocks. They are therefore riskier than securities of more established companies, also known as blue chip stocks.

Risk of penny stocks

Get rich with penny stocks?

Often, penny stocks are securities of growing companies with limited cash and resources. Since this is mostly true of small companies, these stocks are best suited for investors with a high tolerance for risk.

Get rich with penny stocks?

The usually high volatility of these securities leads to a high profit potential with higher risk at the same time. Thus, investors can achieve high profits with these securities, but on the other hand, they can also lose their entire investment.

For this reason, if you want to invest in or trade penny stocks, you should definitely take special precautions. You can do this, for example, by setting a stop-loss order before buying. This will protect you if the price moves against your intended direction. The stock will then be sold automatically when your stop-loss price limit is reached. So you draw a loss limit for this position, so to speak.

Although such cheap stocks can have explosive profits, it is important to have realistic expectations and understand that they are risky investments with low trading volumes.

You can learn more about this topic in our article “Can youget rich with penny stocks?

How are penny stocks created?

As noted earlier, small businesses and startups usually issue stock to raise capital to grow the business. While this process is lengthy, it is often one of the fastest and most effective ways for a startup to obtain capital.

Like any other publicly traded stock, a penny stock is created through the Initial Public Offering (IPO). In this process, the company must first file a registration statement with the SEC or a statement that the offering qualifies for an exemption from registration in order to be listed on the OTCBB.

Furthermore, the company must check the state securities laws in the locations where it intends to sell the shares. Once approved, it can begin soliciting orders from investors.

Finally, the company can apply to have its shares listed on a major stock exchange. On the other hand, they can also be traded over the counter.

Penny Stocks and the Hype from the Reddit Community

Penny stocks have seen increased trading since the beginning of 2020. This did not just happen, but is particularly due to the flood of new private investors into the markets. Many of these private investors chose the Robinhood platform as their starting point.

The experience levels of new traders are broad. Many have never traded before, others have “tried” the markets in the past, and still others want to improve their skills. The way the new group of traders is taking advantage of the easy access to the stock market through today’s technology is definitely something the market has not seen on this scale.

However, it is not only the easy access provided by today’s technologies, but also social media and their communities – such as WallStreetBets and Reddit – that play a significant role in the hype surrounding penny stocks. Because of their reach and popularity, these platforms have become veritable research portals and discussion forums for new investors.

Members of these communities are usually strongly opposed to the old Wall Street ideology of trading and investing. This year, for example, WallstreetBets also became the focal point of the battle between retail investors and large hedge funds. The result was the biggest short squeeze of the year so far in shares of GameStop (NYSE: GME).

These low-cost stocks will be in vogue in 2021

If you want to know which penny stocks are currently particularly trendy and might be worth a look, then take a look here:

• Penny Stocks to Watch in March 2021
• Top Penny Stocks Under 10centswith Big Volume

Or read our post:

Penny Stocks 2021 – 3 Penny Stocks with Potential in the Current Year

What are Penny Stocks - Conclusion

We hope we have been able to give you a little insight into the term “penny stock”. Even though these cheap securities have a high profit potential, you should always be aware that the risk associated with investing in and trading penny stocks is just as high.

If you decide to invest or trade in one of the favorable securities, then take the necessary safety precautions (e.g. stop-loss order), which we have mentioned in this article. Furthermore, you should of course inform yourself in advance as much as possible about the respective company. 

In any case, we are sure that in the future we will hear even more about small companies with favorable securities and explosive price developments. Because that shows the growing interest in the stock market.

FinancialHypes your blog for trends, opportunities and risks on the financial market.

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