Penny stocks may seem more accessible to you than those on the major stock exchanges but they are not for the faint-hearted, and certainly not for those who do not know what they are doing. It is very easy to put your money down on shares that cost less than $5 apiece, but it's important that you know how penny stocks operate, realize how volatile they can be, and do the proper research beforehand.



One would think that investing in penny stocks of small companies might be a bit easier than going for the bigger fish because these companies would have fewer shares of stock and therefore could earn you more if the stocks trade well. True a share is the cost of a hamburger but penny stocks are quite different from the major stocks in many ways. Penny stocks are considered riskier than the traditional stock because of four primary reasons.

Lack of information available

Companies listing penny stocks, especially on the Pink Sheets, are not required to file their financial information with the SEC. These companies are therefore unregulated and not as publicly scrutinized as the blue chip and other major stocks are. Much of the information on these companies is not readily available to the public, and any information you may find, especially on the internet, may not be from a credible source.

No minimum standards

Penny stocks listed on the otcbb and pink sheets do not have to fulfill minimum standard requirements. Many times, this is the reason why companies choose to be listed on these boards. Companies that can no longer fulfill the requirements on the big exchange usually move to the smaller ones where they won't be as closely scrutinized. The OTCBB requires companies to submit documents to the SEC, but the pink sheets do not impose that requirement. Minimum standards act as safety cushions for investors and are benchmarks on the company's financial standing.

Lack of history

Most of the companies listing penny stocks are either newly formed, or are approaching bankruptcy. Generally, these companies would have a poor track record or no record at all. Because of the lack of historical information, it is more difficult to gauge whether the company is worth investing in.

Lack of liquidity

Liquidity how easily you can convert the penny stocks to cash is not a characteristic of penny stocks. If you purchase penny stocks and decide to sell them later on but cannot find a buyer who wants to buy your stocks at the price you want, you may be forced to lower your price for it to be attractive to another buyer. Low liquidity levels also allow for penny stocks to be easily manipulated. It is not unusual for some traders to manipulate the stocks by buying big volumes of it, hyping it up on the internet to make it sound attractive, and then dumping it after many investors buy shares. This is called pump and dump, and is a common occurrence with penny stocks.

Before you invest in penny stocks, make sure you know enough about the company, and that whatever information you are getting about the company and its penny stocks is from a legitimate source. As they say, look before you jump. Otherwise, you and your money may be jumping from your bank account to a frying pan, literally. You don't want to be cooked and lose your savings, don't you?