Getting into the stock market can be intimidating. If you’ve done a little research, you’ve probably heard about penny stocks, and you’ve probably heard that you should stay away from them. The truth is, they can be great, as long as you weigh the pros and cons.
Part of getting over your penny stock fear is understanding why some people don’t recommend them. Here are a few reasons why penny stocks get such a bad rap, and why they aren’t as bad as they sound.
They’re the Mark of a Dying Company
The first thing you might hear about penny stocks is that they’re the mark of a dying company. This can definitely be true. Only low value companies trade in pennies, and many low value companies aren’t going to be around for very long.
It’s important to keep in mind that penny stocks aren’t traded in the major exchanges. They don’t follow the same rules. Some were always penny stock companies, while others get demoted, which is a very bad sign.
However, the opposite could also be true, which is why investing in penny stocks might still be worth your time. Some up and coming companies start out with penny stocks, providing you with the opportunity to make a lot of money in a short period of time.
You Could Lose Everything
You always hear this one with penny stocks—it’s a surefire way to lose all of your money.
It’s true. You could lose all of your money. Penny stock companies are often on shaky ground. That means you could end up losing your entire investment. Add that to the fact that changes in penny stock prices can represent a large percentage loss because they’re so small, and you can see why people stay away from them.
Can’t you say similar things about the stock market in general, though? There’s always a chance you’ll lose all your money. The stock market a game you play that takes finesse—penny stocks are no different.
You May Not Be Able to Sell When You Want
Liquidity is often brought up as an issue with penny stocks. Sometimes, there just aren’t that many stocks to go around. That means you’ll be lucky to find a buyer if you’re ready to sell.
The solution is not to buy illiquid stocks! You should never get into the stock market without doing your homework, and that means not buying stocks without doing your homework either.
There are plenty of stocks out there with enough liquidity to be viable. Avoid the ones with no liquidity and you’re more likely to experience success buying and selling penny stocks.
It Could Be a Scam
This one is huge, and unfortunately, it’s true. Penny stocks are a great way for scammers to take your money. A few notable penny stock scams include:
- Cynk Technology Corp: In 2014, shares for this social network company went up a whopping 24,900 percent, giving the company a $6 billion valuation. Shares then crashed to less than 1/100th of its peak. Turns out the whole thing was a pump and dump scheme.
- Neuromama Ltd: Shares soared from April to August 2016, even though no one really knew what this company did. Turns out the company didn’t report any financials for three years up to that point, making it an obvious scam once investigated.
- Trump Magazine: Even the Donald can’t avoid scams. Premier Publishing Group was created to publish the magazine, but they experienced financial trouble, causing them to sell penny stock shares to the public through misleading practices in an effort to stay afloat.
There’s no doubt that scams exist, but scams don’t keep you from using your credit card online, so they shouldn’t keep you from penny stocks either.
Knowing why penny stocks get a bad rap can actually make you feel more confident about investing. By knowing the downsides, and the corresponding upsides, you can make better investment choices.
Kidal Delonix is a contributor to Mr. Hoffman's blog. The views and opinions are entirely his/her own and may not reflect Mr Hoffman's views.
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