January 5, 2012 | In: General

Are Penny Stocks Safe?

I have defined what a penny stock is before. I have stated that a penny stock is a cheap stock that can be listed in any market. I have also stated that it usually trades in OTC (over the counter) markets, since the financial regulations in such markets are very lax. In this article, I am only talking about penny stocks in these markets.

To answer the main question of this article, the answer is definitely no, and below I will list 10 reasons why penny stocks are not safe at all!

Ten Reasons Why Penny Stocks Are Not Safe

  1. You are investing based on rumors: When was the last time you actually invested in penny stocks based on some solid research? It’s either you’re investing based on some rumors or based on the advice of a friend, a friend of a friend, or even worse, a spam email!
  2. You are not protected: Unlike stock trading that happens in the normal markets and where you are protected when you make a trade, penny stock trading does not offer any protection whatsoever. What guarantees you that the trade that you have made will actually happen? What guarantees you that you have actually bought a share in the company? What guarantees you that the company that has issued the stock actually exists? Here’s my answer, nothing!
  3. What you see is not what you get: There are penny stocks that have a very high volume and there are penny stocks that have a very low volume. Either way it’s not good! When you make a (sell) trade for let’s say 10,000 shares of a penny stock that doesn’t have a large volume, then expect to wait for hours (and maybe days) until someone will actually want to buy your shares, especially when everyone is jumping ship! This means that the sell price that you first see when you execute the trade will not be the sell price at which your shares will be sold. Same thing when you’re trying to buy and everyone is buying (a high volume penny stock), your order may be queued forever and then it will be processed at a much higher price than you initially thought you’re going to pay.
  4. Missing the pump and dump boat: Here’s the lifecycle of any penny stock: 1) List it. 2) Pump it. 3) Dump it. If you miss the pump or dump boat, then expect to lose at least 50% of your money (that if you don’t lost it all).
  5. Too many scams: There are just too many companies (in fact, most companies) that get listed in the OTC just because they want to rob investors of their money. Either the company doesn’t really exist or either the company is lying about its financial sheets. In any case, just getting listed in the OTC means that the company does not meet the minimum standards to be listed in real markets.
  6. You are purely driven by greed: There was a time (not too long ago) when investors used to invest in companies that they believed in. Let’s move forward to now, and to your situation, think about it, why are you investing in penny stocks? Do you actually believe in the company issuing the penny stock? Or are you driven purely by greed?
  7. No tools to help you stop your losses: When you’re buying regular stocks, you have a lot of tools to help you limit your losses: You can buy married puts, you can create a sell on stop order, you can do a lot of things… None of these tools are available for you when you’re trading penny stocks.
  8. Highly manipulated: Penny stocks are highly manipulated, and it only takes a few investors to manipulate them because of their cheap price. If you’re note one of those few investors manipulating the stock, then stay clear, because it won’t be fun for you!
  9. High leverage: Penny stocks are very similar to calls and puts because of their leverage. While leverage is an excellent thing when you’re making money, it’s a terrible thing when you’re losing money.
  10. Penny stocks are a zero sum game: I have demonstrated before that the stock market is not a zero sum game (although I’m sure that there are investors who disagree with me about this – but at least there is a debate), however, the “penny stock market” is a zero sum game. When someone makes a specific amount of money, someone else will lose that same amount of money (or shall I say, when a few make money, many will lose money). The company’s news often have little to no effect on the stock in this case.

And here’s a bonus reason why a penny stock is not safe:

  1. The company issuing the penny stock may just vanish into thin air: There are many companies that issued penny stocks in the past and that have vanished all of a sudden. So, you might be the proud owner of 100,000 shares worth 10 cents each at Company X one day, and then you wake up the next day and realize that you are now the not-so-proud owner of 10,000 shares worth 0 cents each at what was once called Company X.

This article (as well as all other articles on this website) is an intellectual property and copyright of Fadi El-Eter and can only appear on fadi.el-eter.com.

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