Penny stocks are highly risky, mainly due to lack of liquidity and company information, as well as the high volatility associated with low-priced stocks.
Many day traders who want to make money in the stock market prefer to buy low-priced stocks. This is because they provide higher than normal returns.
If you do not apply a reasonable trading strategy, penny stocks can be very risky.
In this article, we looked at low-priced stocks and some of the risks that are usually associated with them.
What is a penny stock?
In the financial markets, the term “penny stocks” refers to company stocks that are traded at very low prices—usually between $0.01 and $5.00.
However, there are no specific rules regarding this definition, and some institutions treat penny stocks as any securities that trade below $5.00.
In most cases, these stocks belong to distressed companies with small market capitalizations that are not listed on major stock exchanges.
Although you may find some in NASDAQ or New York Stock Exchange (New York Stock Exchange), most of them are traded on the over-the-counter (OTC)/pink sheet market, or on the electronic over-the-counter bulletin board (OTCBB) system.
Why are penny stocks so popular
The first reason Low-priced stocks The fact that is so popular is that you can start trading with relatively little funds. I would say that you can start at least $1,000.
Most of these stocks change hands at a price between $0.10 and $1.00, which means that the account size is small. At $1,000, if the stock price is $1.00, you can buy 1,000 shares, and if the transaction price is $0.10, you can buy 10,000 shares.
Another reason is that small fluctuations in penny stocks may bring huge returns. As mentioned earlier, most penny stocks trade at or below US$1. Therefore, even if it only rises by a few cents, it can quickly generate a high percentage return.
For example, if a stock only rises from $0.10 to $1.00, your money will increase 10 times. This is something you hear so much hype by many traders.
The risk of trading low-priced stocks
Now, let us look at the risks of trading low-priced stocks. Why does the market treat these stocks as high-risk investments?
They are often listed by fake companies
Well, the main reason is that low-priced stocks are considered risky because most of them are related to companies that have just entered the market and want to increase their revenue quickly. In some cases, some of these businesses are even outright fraud.
These companies are not subject to the same level of scrutiny as companies whose stocks are traded on listed exchanges. For this reason, any information you find about them may not come from a reputable source, and they can fly under the radar.
Prone to “pumping and dumping” plans
In addition to being provided by the company in question, another risk of trading penny stocks is that they often become targets Pumping and dumping plan.
The skyrocketing plan is the practice of scammers selling specific stocks with the purpose of pushing up their prices through short-term speculation and in the process earning hundreds of thousands of dollars by selling themselves at the highest price (dumping).
This illegal behavior ultimately caused innocent traders who bought stocks when the stock price rose to suffer huge losses when the stock price plummeted.
The liquidity of penny stocks is extremely poor. These stocks also tend to have high insider ownership and leave a small amount of free float for the general investment public.
This means that even if the stock price rises, many traders may not be able to sell before the stock drops again.
They are very unstable in history
For individuals with low-priced stocks, cheap stock prices are a great attraction. However, these very low stock prices mean that they are extremely volatile, and their volatility can rise by more than 100% in a day.
These violent fluctuations occur when a fundamental catalyst brings many new buyers into the stock. Catalysts can be press releases, rumored acquisitions, earnings, activist investors, new contracts, FDA announcements, or other types of breaking news.
The downside is that if a stock can rise by more than 100% in a day, it means that it can also go downhill in the same way.
How to protect yourself from risks
Because of their low prices, penny stocks are very attractive to first-time day traders. But these stocks also attract fraudsters and scammers who profit from misunderstandings and misunderstandings.
So, how do you protect yourself from the risks associated with these stocks, including plans for skyrocketing and plummeting?
The simplest answer is to avoid low-priced stocks listed on the unregulated over-the-counter market. If you want to try stocks under $5, stick to stocks listed on regulated exchanges (such as Nasdaq, New York Stock Exchange, or American Stock Exchange).
In addition, thoroughly researching penny stocks before trading can help you avoid huge losses. Don’t follow the free penny stock picks, they are likely to use dishonest strategies and information to induce you to buy, and sell the stock immediately after persuading enough people to buy.
Identifying the best penny stocks for day trading is an excellent profit strategy. But like many things in life, finding the best thing is easier said than done.
The most important thing to remember when trading penny stocks is that these instruments are highly speculative. All stocks are speculative to some extent, but the low prices of low-priced stocks make them particularly vulnerable to intense intraday volatility based on news events.
Ultimately, informed and disciplined traders can make money by trading stocks for less than 5 cents.