Investing in penny stocks is like buying a temperamental sports car from the guy down the street. The car might get you a few good runs down the track on Sunday afternoons, or it might just turn into a black hole for spare parts.
What are penny stocks and how do they work?
Companies that have low share prices and trade their stocks, do so in the form of penny stocks. As the name suggests, these stocks are smaller in value than some of the larger listed companies. Share prices are typically under £1.
While other shares are traded on major exchanges, these are typically traded over the counter (OTC) or in the form of pink slips.
Are penny stocks worth investing in?
As with all investments, it’s important to do research before parting with your cash. Well-researched penny stocks from good companies that show a healthy growth pattern might turn into a decent investment. The key, however, is finding penny stocks worth investing in. Some of the key pointers include:
- Good companies with a solid track record: Have a look at the history of the company and try to find information on funding rounds, patents pending and other key information that would indicate a decent win or at the very least, a solid growth trajectory.
- Past performance: While past performance is no guarantee of future performance, it does make the decision-making process a little easier.
- Industry type: Some industries are just higher risk than others.
Are they high risk?
Penny stocks are deemed as extremely high risk even though the investment required is fairly low. This is because penny stocks predominantly focus on the success or failure of businesses. These stocks are not traded on listed exchanges, which means that the companies have less oversight, but also less government protection.
For instance, a listed company like a bank might have a better chance of a government bailout than a mom-and-pop shop down the road.
Some investors feel that the high risk leads to high reward, but this is often untrue.
What are the advantages and disadvantages of trading penny stocks?
- Low barriers to entry as stocks are low in value
- Profit can happen on the way up or down
- Small accounts and small balances are allowed
- Very high risk
- Low-quality companies
- Open to manipulation and fraud
- The get-rich-quick lure makes them seem scammy
Are you likely to get rich with penny stocks?
The likelihood that you’ll make money will depend on your ability to research the companies you invest in, market conditions, and a slew of other factors.
Some traders who made it big…
Tim Sykes is a well-known trader who decided to use his bar mitzvah money to invest in penny stocks. He is known to have turned $12,415 (roughly £9,150) into $6,256,287 (around £4,612,000).
Another successful penny stocks trader, Tim Grittani, traded $1,500 (roughly £1,105) in 2013 and now has a $1 million (around £737,000) strong portfolio.
…And those who didn’t
While there aren’t many articles on the losers in penny stocks – of which, it has to be said, there are countless – there are those companies known for destroying 75% to 90% of their investors’ wealth. These include Gemini Communication, Lanco Infratech, and more.
In conclusion, I’m of the firm belief that novices are best off avoiding penny stocks, and there are better places to put my hard-earned money than in highly speculative investments.