What is a Penny Stock?

What Is A Penny Stock?

A penny stock is a publicly traded company that has low capitalization, a low stock price and does not trade on one of the major stock exchanges. Penny stocks used to be classified as any stock trading for less than $1 (hence the name), but today most consider any stock trading under $5 to be a penny stock.

I guess the term “Dollar stock” doesn’t roll off the tongue quite as well.

Picking Individual Stocks is Risky

Anyone who had followed my writing for any length of time will already know that I am not a fan of picking individual stocks.

The only reason anyone would ever consider picking individual stocks is that they feel they can beat the average stock market return. They believe the return on investment on the stocks they choose will be higher than the average return of the stock market.

While there is the odd person, like Warren Buffet, who has consistently beaten the market these people are exceedingly rare and should be considered the exception, not the rule.

There is no shame in admitting you cannot predict the future or the stock market. The cards are stacked against us, as the human brain has evolved in such a way that makes us terrible investors.

Additional Risks Involved with Penny Stocks

If picking individual stocks is risky, picking individual penny stocks is pure gambling. There several factors that make “investing” (I use that term loosely) in penny stocks so risky.

Lack of Information

If you do insist on trying to pick individual stocks, it should be done based on the research you have done about the companies you invest in. It can be very difficult to find information on penny stocks because they are not subject to the same level of scrutiny from regulators as stocks listed on a major stock exchange.

Low Levels of Liquidity

Penny stocks by definition have very low capitalization rates, do not trade on a major stock exchange and therefore have very poor liquidity. Which means it could be difficult to find a buyer if you decide to sell your penny stocks.

Penny Stocks are more Likely to go Bankrupt

Most penny stocks are companies that are either new businesses or are existing businesses approaching bankruptcy. Both new businesses and companies in financial distress are more likely to be a loser than proven stocks with a long track record trading on major stock exchanges.

Why Would Anyone Buy Penny Stocks?

Investing in penny stocks sounds like a terrible idea so the natural question is “why would anyone invest in penny stocks?”.

The short answer would be, greed.

We have all heard the term “high-risk, high-reward”. Penny stocks are extremely risky but if somehow you pick the right penny stocks it can be extremely lucrative.

It’s not dissimilar from going down to the Casino and picking numbers on the roulette table. Chances are you are going to lose, but if you win, you’ll win big.

I personally do not know anyone who invests in penny stocks, so I can only speculate but I imagine these people have an extremely high tolerance for risk, supreme confidence in their stock picking ability and too much money and time on their hands.

I don’t care how rich I get, I am happy sticking to ETFs and taking the market return.

This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.