The Risks Of Trading Penny Stocks

With the introduction of online discount brokerages in the past decade, small investors have begun to flood the markets with additional capital. Unfortunately, their inexperience often gets the best of them, as is apparent by their increasing interest in trading penny stocks. There are several risks associated with investing and trading in companies whose stock prices have fallen to low levels. Taking these risks into consideration can save a small investor a lot of pain in the form of great losses in capital.

Companies with shares that have dropped as low as a dollar are usually not in the greatest financial situation. More often than not, management is doing a poor job running the company, or the company’s main product isn’t selling well. Neither of these instances warrant any increased interest in the company’s shares, yet the hope for a quick fortune is sometimes too strong to ignore. A careful investigation of the company’s financial strength and future prospects would almost always clearly indicate that a company trading around a dollar a share is probably a poor investment.

Trading Penny Stocks Is A No-Win Scenario

Paying attention to the price of the shares which you intend to invest in is also important when taking your commissions into consideration. Many online brokerages will charge a surcharge per share for any investments in a company which trades below a certain price ($2.50 is a common cut-off). This additional cost should make any small investor even more skeptical towards purchasing shares of companies that have dropped to extremely low levels. When working with a small amount of capital (and even when working with a large portfolio), your returns will be negatively affected by excessive investment costs.

Regarding the added risk taken on by investing in shares that have a low price, there is an important warning to heed. The majority of small investors choose such shares because they feel that the prices can only go up, that these shares can’t very well reach zero. This is false: share prices can absolutely hit zero, and if you purchase a large volume of shares at a low price, it doesn’t take much to wipe you out completely.

While small investors are generally attracted to low share prices, they would be much better off looking at stronger companies with reasonably-priced securities. Value in the stock market is determined by much more than just share price, so be sure to take all the factors into consideration when investing. Doing so will no doubt have you steering clear from so called penny stocks.