Last Updated on December 29, 2020 by Henry John
WISDOM says, “Get all the facts, before you jump into penny stock investing”.
Nio stock started this year as a penny stock and now it has grown over 1000% YTD. Overstock.com was trading under $3 as penny stock back in March and it now trades over $60, posting over 1500% in returns. Back in 1997, Amazon’s stock started trading publicly as a penny stock under $2 and now trades over $3,200 per share.
Penny stock investing has proven over and over again to be capable of bringing in mind-blowing ROIs, whether on the short-term or over the long-run.
So, is penny stock investing the best form of stock market investing?
Should you go all-in in investing in penny stocks?
Are there things about penny stocks that should worry you?
As J. Michael Straczynski once said, “Remember, there are two sides of every story. Understanding is a three edged sword. Your side, their side and truth in the middle. Get all the facts before you jump to conclusions.”
There are indeed two side of the penny stock story (the good and the bad), and three sides of its sword (the winning, losing and the breakeven side).
The advantages of penny stocks make them very attractive and there is little wonder why there are many penny stock traders. However, the majority of penny stock traders lose money trading penny stocks, and this speaks volumes.
Some brokerages charge higher commissions for trading penny stocks which sometimes eat deep into profits, turning a profitable trade to a break-even trade and a break-even trade to a huge loss.
I’ve written a lot about penny stocks in different markets, like renewable energy penny stocks, 5g penny stocks, artificial intelligence penny stocks, blockchain penny stocks, and electric vehicle penny stocks. And this makes me feel that at the very least, it’s my responsibility to inform you about the potential pitfalls of investing in penny stocks.
Penny stocks can be rewarding and with the potential rewards come the risks, here are 5 major disadvantages of investing in/trading penny stocks:
1. Many penny stocks are unpopular and trade on unstandardized markets
Many penny stocks don’t trade on the major national stock exchanges like NASDAQ or NYSE. They mostly trade on OTC Bulletin Board and the Pink Sheets Electronic Quotation Service.
OTC Bulletin Board (OTCBB) and the Pink Sheets Electronic Quotation Service are merely a quotation service and not stock exchanges. They were created to help small companies that cannot meet the requirement for joining major exchanges to still be able to receive financing from investors. Companies trading on these platforms are usually called over-the-counter stocks.
As one would expect, these quotation services are not regulated like the standardized national exchanges. The most striking thing for me is that even reporting is unregulated and it’s hard to find news about these OTC stocks because of their relative unpopularity. All these make it difficult to genuinely analyze these penny stocks fundamentally.
There are many more reasons why companies trade OTC beyond failing to meet the requirements for the major stock exchange. Some of the other reasons are:
- They get de-listed from major national stock exchanges
- The company falls off as a result of its stock price dropping under $1.00
- The recent legislation cleared by the House threatens to kick foreign companies off major US Stock Exchanges if they continue to deny US regulators access to their audits, and if this happens, the kicked out companies can still trade OTC. Companies that don’t want to meet the requirements of major US Stock Exchanges opts to trade OTC.
Just in case you are wondering, only a handful of companies make it from trading OTC to a major national exchange. And this should paint a picture of its own.
2. Trading/Investing in penny stocks increases your exposure to fraud
“California resident Zirk de Maison, a self-described merchant banker, devised a plan to make himself some easy money off the backs of hard-working folks. From about 2008 to 2013, he created nearly a half-dozen small public shell companies – entities that do no actual business and have no assets. He then offered public shares in the company’s penny stocks…” FBI 2017 Press Release: Penny Stock Fraud Nets Millions.
Yes, the stories you hear about penny stocks are real, the scams are as truthful as portrayed. Trading penny stocks, especially OTC penny stocks are risky.
Since most OTC stocks are not popular, rarely make the news and trade in unregulated markets, trading such penny stocks is often a Hail Mary move.
There are several form of penny stocks fraud such as:
- Dump and dilute schemes
- Pump and dump schemes
- Offering chop stocks
Penny stock frauds can also be carried out by dishonest brokerages through practices such as bait-and-switch, carrying unauthorized trading on your behalf, and establishing policies that prohibit customers from selling stocks.
The penny stock world is a tricky one, navigating it successfully is no small feat.
3. Penny stocks are typically volatile
Many penny stocks are thinly traded and this makes them highly volatile. Small volume movement north or south sends stock prices down and up respectively.
This volatile nature of penny stock could entail that one can easily lose a lot of money investing in penny stocks. Perhaps, it’s one of the thing that makes penny stock attractive: the fact that it doesn’t take much for the stock price to move significantly.
Few seasoned penny stock traders flourish in volatility and since, you are probably not one of the few seasoned penny stock traders, highly volatility nature of penny stocks can screw you badly.