Written by Charlotte Wood (last updated February 21, 2009)
Penny stock has a nice ring to it; penny indicates inexpensive and we could always go for something a little less expensive, right? However, what exactly is a penny stock and what are the risks associated with it? While penny stocks may be cheap and exciting (and potentially lucrative), the risk factors needs to be considered and you need to decide whether or not it's worth it for your money.
A penny stock is any stock bought outside the major markets (NYSE, NASDAQ, AMEX) and isn't usually looked upon favorably by traditional investors. A stock is usually considered a penny stock if it has a market cap under $500M dollars. When you buy a penny stock, you're buying stock traditionally in a very small company that's trying to get going on the business track. Because the company is so small, the stock shares are unbelievingly cheap because the company is really just looking for investors so they can expand. Also, because the stock shares are so inexpensive, penny stock investors tend to buy a lot and spend a lot of money.
A very high level of risk accompanies this kind of investment, however. Events can go one of two ways: either the company will take off, potentially making you a multimillionaire, or the company will tank, leaving you with nothing. The outcome of your investment hits two extremes and you need to decide whether or not the risk is worth it for you. You also risk some degree of fraud when investing in penny stocks; without the company in the stock exchange mainstream there's little verification of legitimacy. Over-the-counter penny stocks are especially speculative because their legitimacy is definitely questionable.
If you can afford the risk, investing in penny stocks could be exciting and could lead to exciting outcomes, but you really just need to be careful. Use prudence when conducting this business and if anything seems out of the ordinary or fishy, back out of the deal. It's your money and you should be careful with it.
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