Penny stocks---microcap stocks---are stocks that typically cost less than a dollar, but can be upwards in price to five dollars. While these are often very affordable, they're also very speculative and have several drawbacks for traders. The lower the cost, the more speculative the stock usually is.
Sometimes growing and profitable companies just starting out begin as microcap stocks and grow enough to get on the major exchange. Sometimes they are just shell companies, companies incorporated but without any assets or even a business plan. While you might be able to make money on these types of stocks, it's more like gambling than investing.
On a penny stocks just like any other type of investment, one should gather as much information on the company as possible whether it's fundamental information or statistical information on the movement of the stock. It's not always easy to find either. These stocks are typically traded on the Pink Sheets or OTCBB---Over the Counter Bulletin Board.
Companies on the Pink Sheets don't have to file with the SEC. That makes them far less regulated than those on the NYSE or Nasdaq. If you're hoping to find information on the internet, you might find it, but it can be created by investors who want to drive the price up or the owner of the stock symbol---which is all there is to the company sometimes. This information is often misleading and aimed at getting you to purchase the stock so they make money.
Stocks on the OTCBB or Pink Slips don't have minimum standards to meet to remain on the exchange, unlike companies on Nasdaq or NYSE. That means there's no minimum benchmark or safety net for investors when they purchase microcap stocks. While some of these stocks may be fledgling businesses on the road to success, others may be hiking down the road to bankruptcy. There's simply no way to know since there is no history on the stock to find out, so you're making a purchase blind.
One of the big problems with these microcap stocks is the inability to sell them. That's because there's often not enough activity in that stock, you may not have a buyer available. Sometimes, the market is controlled or manipulated by other investors, known as pump and dump. They purchase a large amount of the stock and hit the message boards with glowing information, creating interest. If the stock sells for a fraction of the penny and this type of investor drives the price up two cents, a thousand dollar investment can reap huge rewards for these unscrupulous type of person.
A less than scrupulous market maker can also make a fortune for themselves at your expense when dealing in microcap trading. Market makers can sit on your trade, fill it with a price higher than that quoted---which is why you always use a limit order when dealing with penny stocks. Market makers can also have huge spreads, making it almost impossible for the investor to make a profit.
Despite all the disadvantages of these types of stocks, there's plenty of money to be made with a very small investment if you study the market and the stock before you enter into a trade. It's no different than any other type of trading, there are just more pitfalls and you have to be more careful traveling on the path to successful trading.
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