How penny stocks are traded – and why they’re so risky for investors
But not all penny stocks are the same, and one of the factors that sets them apart is where they trade.
How are penny stocks traded?
According to the United States Securities Exchange Commission (SEC), penny stocks are stocks that trade for less than $ 5. Some of these businesses are new to the market, may not have complete financial records, or may not have a strong product, service, or revenue stream. In some cases, some of them could even be subject to bankruptcy.
Companies with all their documents in order can be listed on major stock exchanges like the NYSE or NASDAQ, which have strict rules, such as frequent disclosure of financial statements to the SEC.
Since most issuers of penny shares are not eligible to be listed on a major exchange, their shares trade over-the-counter (OTC) through the OTC Bulletin Board (OTCBB), an electronic trading service. managed by the Financial Industry Regulatory Authority, or through the private Pink Sheets Market.
For penny stock issuers who file financial statements with the SEC, their ticker symbols begin with an “OB” suffix on the OTCBB. For penny stocks traded on the Pink Sheets platform, their ticker symbols have a “PK” suffix.
For retail investors, it is important to note that OTC transactions take place between parties outside of a major exchange and without the supervision of a stock exchange regulator or market maker to ensure the liquidity of the share.
The lack of a more stringent listing process and low liquidity, for example, open the door to many risks such as potential market manipulation.
What other factors make penny stocks risky?
Investors often rely on publicly available information to assess a potential investment opportunity. This information may come from reputable media, a broker’s research team, documents filed with the SEC, etc. However, these materials can be difficult to find for small businesses and may not always come from reliable sources.
Since some of the penny stock issuers are newly formed, historical data is unlikely to be available, making it difficult for investors to assess current and future valuations.
Likewise, not all corporations are required to disclose financial statements. As a result, these companies may not benefit from the same level of investor oversight as more established names like blue chip stocks. Pink Sheet stocks are considered the riskiest because issuers are not required to disclose financial information.
Low trading volumes also provide astute traders with opportunities to take advantage of volatility, which often causes penny stock prices to artificially increase (or sometimes lower).
For example, in a “pump and dump” system, traders will trick investors into the next “hot stock,” causing the stock price to rise rapidly as buy orders arrive. But when investors come to their senses and realize that inflated prices are likely unwarranted, those stocks often crumble, leaving those who bought at high levels to hold the bag.
Are penny stocks a good investment?
For small businesses, publicly listing their stocks helps them access public funding, which can be their lifeline as they try to grow. And for investors, supporting successful businesses can be lucrative, especially if those products or services really take off.
Of course, for investors, identifying a winner in a sea of penny stocks could be seen as finding a needle in a haystack.
When it comes to penny stocks, the appeal to traders is the ability to achieve large returns with small amounts of capital. So while a large stock like Apple typically trades in a 2% range over the course of a day or week, a penny stock might see its stocks move north of 10% or more in the two ways in a single day.
Due to the additional volatility and the low stock price, many penny stock traders see it as an opportunity to make quick profits. And to mitigate the risk associated with companies that trade over-the-counter, they are attacking penny stocks listed on major exchanges like the NYSE.
There are many strategies on how to trade penny stocks. But, as with other investments, it’s always safe to do your homework, look at the financial records, start small, and avoid letting greed or fear influence your decision-making.
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