A Brief Explanation About Penny Stocks
Over the past few years, penny stocks have been receiving poor criticisms. Several stock marketplace gurus claim that investing on these kinds of stock is very risky. Even the Securities and Exchange Commission would ask investors to be extremely cautious in dealing with penny stocks. But what genuinely are penny stocks? Are the risks real or are they just invented by firms trading in major stock exchange markets?
Penny Stocks Defined
Typically, penny stocks are defined as those stocks with a marketplace value of much less than one unit of the local currency. Within the U.S., this would mean that penny stocks are those that sell for much less than a dollar per share. This definition, however, is not usually followed, for it's not uncommon for one to find penny stocks that sell up to $5 a share.
To clear things out, the Securities and Exchange Commission have also come up with its own definition of penny stocks. According to the SEC, any stock under $5 is a penny stock. Once more, this definition may not always be followed, as some would set the penny stock cut-off point at $3.
For less complicated identification, one can further define penny stocks as those stocks which are traded outside formal exchanges like the NYSE and Nasdaq. Specifically, these stocks are traded on over the counter (OTC) markets and are quoted on Pink Sheets or on Over the Counter Bulletin Boards (OTCBB).
Penny Stocks and Microcap Stocks
In trading, the terms "penny stock" and "microcap stock" are typically used interchangeably. Technically, even so, the two are fairly diverse in the sense that they are defined not making use of the exact same bases. Whilst penny stocks are classified based on their price, microcap stocks are classified based on their marketplace capitalization.
Microcap stocks are defined as those stocks that are traded by tiny businesses with low or "micro" capitalization, thus the term "microcap". These capitalizations normally fall under the range of $50 million to $300 million.
Since microcap stocks would normally have the same characteristics as penny stocks (that is, they're low priced and traded in low volumes), the two terms are often used interchangeably. Further, microcap stocks are also quoted on Pink Sheets and on the OTCBB.
Firms That Trade Penny Stocks
A lot of firms trade within the OTC market, despite the fact that these businesses are usually classified in three groups:
* New or small companies which are unable to meet the initial listing of formal exchanges.
* Companies delisted from major exchanges, normally because of failure to meet filing requirements, running into financial troubles, or running into bankruptcy.
* Big companies that simply pick the OTC market over main and formal exchange markets.
Risks of Investing in Penny Stocks
Among the three types of businesses that trade within the OTC market, investing on penny stocks traded by the very first two would entail the greatest risk. And while investors could have luck on the last, dealing with them would still necessitate excellent care.
You can find four major factors why investing on penny stocks is risky and these factors lay on the characteristics of penny stocks.
* Lack of Public Info
Information is the key to any productive investment strategy, and without any public info obtainable, there's a really diminutive opportunity of being successful in penny stock investments. Organizations listed on Pink Sheets aren't required to file with the SEC, making penny stocks a whole lot harder to scrutinize than the stocks listed on main exchanges.
* No Minimum Standards
Significant exchanges like Nasdaq and NYSE have minimum regular requirements that member organizations are compelled to fulfill. These requirements would typically serve as safety cushions for the investors. Pink Sheets don't require the fulfillment of any of these standards, even though the OTCBB would need businesses to file timely documents with the SEC.
* Lack of History
Several penny stock trading organizations are fairly new or approaching bankruptcy and these firms generally have poor track records or maybe none at all. Like the lack of public information, lack of organization history makes scrutinizing penny stocks a lot more hard.
* Low Level of Liquidity
You will find two reasons why one really should stay away from stocks having a low level of liquidity. Initial, these stocks are hard to sell. Second, traders frequently manipulate the prices of these stocks. Any of the two reasons would spell disadvantage for any investor who buys shares in a penny stock.
Risks are inevitable in any kind of investment but the risks of investing in penny stocks greatly outweighs the risks that one would need to make when investing in major exchange markets. But really should an investor still pick to invest on these types of securities, he much better be careful and armed having a lot of info, which is really challenging to locate, about the organization he is trading with.
Article Source: FxTradingStock.com
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by: Devon Reyes
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Word Count: 856
Date: Fri, 11 Feb 2011
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