What Are Penny Stocks and Why Are They Bad for New Investors?

Becoming an investor is easy, but it requires one thing that not everyone has: money, and a decent amount of it.

If you wanted to buy shares of Apple stock, for example, you can’t just fish coins out of your pocket and buy a share. As of this writing, a single share of Apple stock costs a little over $109. You can’t haggle with a broker and buy a percentage of a share; you have to buy the share in full, and some people just can’t afford this.

That’s why penny stocks exist. These stocks are incredibly low in price and can yield significant returns on the market. If you wanted to buy five shares of a penny stock, you wouldn’t spend more than $25 to do so.

Yet penny stocks aren’t like regular stocks. They come with higher risk, lower liquidity, and can actually be worth a lot less than investors say they are. If you’re a brand new investor and just starting off in the financial world, here’s why you might want to avoid these stocks entirely.

Penny stocks are stocks that trade at low prices.

These stocks sell for under $5, and their companies don’t offer nearly as many shares as other publicly traded companies. They’re mostly listed on “over-the-counter” exchanges, which aren’t as strict about regulation and other formalities like the NYSE or NASDAQ are.

The low point of entry allows for these stocks to make faster, bigger gains…or losses.

When investing in penny stocks, you can make bigger gains on a single stock in a day. Unfortunately, that means you stand to lose more on that stock in a day. Also, if your stock is down, you won’t be able to sell it as easily as you would on a major exchange. That’s because penny stocks aren’t in incredible demand like companies trading on major exchanges, and there aren’t as many people willing to buy them. This could mean you’re forced to hold on to a bad stock and potentially lose all your money.

Penny stocks are highly susceptible to scams.

Since companies trading on an over-the-counter exchange (like OTC.BB) don’t need to offer as much info about their company, penny stock investors could actually be buying into fake companies, or companies who aren’t actually doing too hot. Awful companies and unscrupulous investors alike regularly value penny stocks at more than they’re worth and sell them at a huge profit, leaving unsuspecting investors with worthless stocks that they paid too much for. Since there’s no regulation of the OTC exchanges, they could totally do this — though they could also totally go to jail for these schemes.

Some investors make a killing in penny stocks, but those success stories are far from guaranteed to repeat. If you’re just starting to invest, you should probably avoid penny stocks. With higher risk than regular stocks, low liquidity, and the chance of being scammed out of your money, there are far better things to invest in.


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