Investment Strategy

The Lure of Penny Stocks

(SOMEWHERE IN FLORIDA) — It’s hard to check your email without hearing about the next “hot” penny stock or the newest pill that’ll increase your manhood a few inches. But the latter has nothing to do with this article; I’m just saying its annoying how many of those spam emails we receive. It’s not just me, right?

What this article is about is understanding exactly what penny stocks are and whether they can deliver on those incessant e-mail promises.

What Are Penny Stocks?

Penny stocks are low-priced, small-cap stocks and contrary to their name, penny stocks rarely cost so little. The SEC considers a penny stock to be pretty much anything under $5. While there are sub $5 stocks trading on big exchanges like NYSE and NASDAQ, most investors don’t consider these when asked to describe a penny stock.

Most individual investors look at penny stocks like they would a low-rent pimp house –an untamed world of investing separately from the glitz and media coverage that comes with stocks that are traded on major exchanges (essentially, comparable to a the high-charging, high-class escort service). While the gains and losses can be impressive in the penny stock world, they’re not often heard about elsewhere.

Penny stocks are not without their drama. Because apparently dealing with Wall Street and investments is like dealing with a batshit crazy girl, the reward is worth the risk to some. And just like unstable females, penny stocks have also garnered a reputation as a game filled with scams and corruption. Indeed, penny stocks could be your wildest ride yet as an investor (if you don’t include the hooker you met in Vegas).
Because penny stocks aren’t traded on normal exchanges, people interested in such investments have difficulty knowing where and how to buy them.

How to Buy Penny Stocks

Like any other stock you would buy, you can purchase shares through your normal stockbroker — regardless of whether it’s listed on the major exchange.

It’s important to note that penny stocks and cheap stocks aren’t exactly the same and “cheap stocks” may be a better option. While cheap stocks listed on exchanges like NYSE and NASDAQ aren’t typically considered “penny stocks,” they can afford a lot of the benefits of the latter without so much volatility. These exchanges have strict listing requirements but are more reliable than penny stocks. But if you are interested in true penny stocks trade, you can find them on listing services like OTCBB and Pink Sheets.

Over-the-Counter Bulletin Board, or OTCBB, is a quotation. Unlike Pink Sheets, which is just a quotation publisher, OTCBB maintains listing requirements (though they’re less stringent than those of a normal exchange). For this reason, OTCBB has a little bit of added legitimacy. Which makes sense because investing through anything called “Pink Sheets” intuitively doesn’t sound like the smartest decision.

While Pink Sheets sounds like the name of a sex toy store, in actuality it is a system that provides investors with quotation information on stocks that are registered with it. Unlike OTCBB, however, Pink Sheets isn’t registered with the SEC and doesn’t enforce any listing requirements. Bottom Line: Pink Sheets stocks are risky. But if you like to live on the wild side like putting ketchup on your steak or not using condoms, this might be right up your alley.

The Potential Payoff of Penny Stocks

Because penny stocks are prone to violent fluctuation, many people believe that they’ll luck out with a stock that will jump from $0.07 to $7 in a few weeks. And that’s not uncommon. Do your research and you’ll be sure to find success stories from investors who made a mint while “playing the pennies.”

Companies that can successfully make the jump from penny stock to power stock are rare, but when you find them, they pay out astronomically. Numbers vary quite a bit but investors have raked in gains over 1,000% in a few weeks’ time. The real trick is finding the right stock.

The Risks of Investing in Penny Stocks

Two principal reasons that risk is so inherent in penny stock investing is low liquidity and poor reporting standards.

As investors have seen with subprime lending markets in the past, liquidity problems can be a huge deal for investors. And unlike lending, low liquidity plagues the penny stocks daily. Because this sort of investing is such a niche area, even relatively low trade volumes can have an impressive effect on a stock’s share price. According to the SEC, penny stocks may trade infrequently, which means that it may be difficult to sell penny stock shares once you own them. It’s kind of like getting stuck with a timeshare. It may sound like a great investment, but once you try to get rid of it, you end up probably losing financially.

The bottom line: Investing in penny stocks is like playing the coin machines at a casino. The return probably won’t be noteworthy but there’s always that little old grandma that ends up leaving with millions, and you might be her.

Investment Strategy