The lure of cheap stocks offering high rewards often appeals to many inexperienced investors who want to quickly generate high returns. However, cheap stocks, also known as penny stocks, are extremely volatile and sometimes dangerous. Penny stocks have been known to wipe out many new investors’ entire portfolio. Here is a closer look at penny stocks and why they are almost never profitable.
What is a Penny Stock?
Investors refer to penny stocks as companies whose share price trades below $1.00. The SEC considers companies that trade below $5.00 as penny stocks. These companies typically have no market capitalization and no profits. Companies with such a low share price normally trade on the over-the-counter stock markets and on the pink sheets. These stocks can go days without any market activity and no trading volume. Often times these stocks have very wide bid/ask spreads and no liquidity. The most successful investors almost always stay away from such volatile stocks.
Finding the “Next Big Thing”
It is not uncommon for investors to scour through countless penny stocks hoping to find the next Apple or Google. The lure of getting a “piece of the action” can lead investors into a dangerous game that puts their portfolios at risk. The chances of finding the “next big thing” in penny stock listings are the equivalent of finding a needle in a haystack. Most finance experts agree that researching penny stocks for the next Amazon is a waste of time, and investors should use that time to learn how to invest in the stocks of companies trading on the major market averages.
Little to No Liquidity:
Most penny stocks have little to no liquidity, which makes them very difficult to trade. Many inexperienced investors might think they are getting a deal when they buy a company’s stock for $.10 or less per share. However, when it is time to sell those shares, those investors might have a hard time finding buyers. Additionally, companies with little liquidity are targets of stock manipulators who like to “pump and dump” those shares.
For example, fraudulent brokerage houses or traders will pump up the stock with the false promise of some major breakthrough while simultaneously buying a significant amount of shares, which then causes the price of the stock to rise. Once the stock reaches a certain price, those same brokers or traders will then sell their shares of stock at huge profits while regular investors are stuck with worthless stock.
Yorkville Advisors, LLC is a privately owned and operated hedge fund sponsor that was founded in 2001.