What Are Penny Stocks and Why Investors Buy Them

what are penny stocks

Investors who invest in penny stocks know the vast potential these stocks have. Turning a small investment into a fortune is possible when the shares are backed by thorough research on fundamental and technical aspects of the company as well as chosen wisely.

But what are penny stocks and why investors buy them, especially in 2019? Let’s take a look.

What Are Penny Stocks?

Penny stocks are stocks traded at a meager price. For example, in Western markets, these shares are traded below $1. They have low market capitalizations and are mostly illiquid. Due to the lack of liquidity and the fact that these stocks are very speculative, penny stocks are considered highly risky.

Also, they are cheaply priced in the market because these are either small companies or start-ups. Penny stocks have a lower number of shareholders, large bid-ask spreads as well as limited disclosure of information.

Penny stocks are usually listed on a smaller exchange, and the market capitalization of these stocks is generally lower than the common stocks. These companies have a small balance sheet and limited resources.

But why investors pick penny stocks for their investments, and are penny stocks considered a good investment? Let’s find out.

Why Investors Buy Penny Stocks?

Currently, many companies are trading for pennies. These companies have proven management teams, exceptional financial positions, growing market share, improving financial ratios, and disruptive products or services.

Penny stocks are attractive to investors for a few other reasons. Let’s have a look at some of these reasons.

Low Price per Share and High Volatility

Penny stocks have a low price per share, as well as relatively high volatility. This allows new investors to begin investing with a small amount of money. Also, it might be tough for investors to earn dividend income from these stocks.

These companies distribute a minimal amount of dividends relative to the price of the stocks. If investors want to generate dividend income, they should buy and hold the shares in massive numbers.

Substantial Returns and Speed

Penny stocks have the potential for significant returns. Some stocks don’t move quickly in price, while others make their big price moves within days. Also, with penny stocks, investors don’t need a considerable amount with which to start trading.

If the investor has a capital of $1,000, he has the chance to double his money in no time. Imagine the following. The investor buys 1,000 shares of a penny stock priced at $1.

1,000 x $1 = $1,000 capital

If the share price jumps with $0,50, what will happen? The investor will earn 1,000 x $0,50, which equals $500. But if the price jumps with just a $1, then the profit will equal $1,000.

Also, stock exchanges put penny stocks in a different category than other stocks. The category of penny stocks is called “trade-to-trade basket.” No intraday share trading is allowed in this category.

What Are the Downsides of Penny Stocks?

Penny stocks have a lot of downsides too. Penny stocks are prone to sudden delisting, regulatory scrutiny, price Manipulations, and volatility, as well as scams.

With penny stocks, one investor has the power to move the stock by buying thousands of shares. By doing so, the investor creates a spike.  This makes it difficult for other investors to determine whether the spike in price is genuine or manipulated.

Also, penny stocks are not regulated by a national-level stock exchange. While some penny stocks are low-quality companies, others are scams. They either have a questionable product in a dying industry with numerous competitors, or they even don’t have the product they are selling.

In the second situation, everything the company does has one purpose – to trick investors out of their money.

The Bottom Line:

Penny stocks or also shares of a company that are traded below $1 are an excellent option for investors who are not afraid of investing in new companies or start-ups.

As penny stocks are risky and volatile stocks, investing in them requires patience, skill, and experience. Only when chosen wisely and after in-depth research, the investment could prove to be a good pick.

If you are a new inexperienced investor, or you don’t have enough time for in-depth research, we have good news for you. If you are eager to find out which are the top 3 penny stocks for this year, you should read 3 Top Penny Stocks To Buy in 2019”.

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