People enjoy a discount. Shares that have low costs look like great discounts. Several of the shares cost a lot of money to acquire in the financial markets. Here is where penny stocks come in. You may ask what penny stocks are. These are shares that have prices that are less than five dollars. This can look like a great way to increase your cash in a swift manner. But, these penny stocks have gained a reputation over the years for causing losses to many investors. It is not impossible to get great returns by putting your money in young firms that have tiny valuations or low prices on their shares. But it is usually better to invest only in firms that are bigger and do not have such speculative valuations. All risky share purchases should at least be restricted to stocks of firms that give meaningful revenues or have realistic and clear roads to your growth as an investor.

This article will tell you all about penny stocks and how you can identify them. After this, you will be able to identify good penny stocks on your own. Let us look at why penny stocks do not have such a great reputation among investors in the financial markets.

What Is A Penny Stock's Money Making Abilities?

It is not impossible to get good returns on investments in penny stocks. But it is theoretically possible to create profits with any kind of shares. Investors who are successful in the financial markets typically focus on the profit potential for the shares of their choice. They choose the shares without any regard for their price. Their aim is to get value over the long term. There are many reasons to invest in small firms. The people who purchase stocks in fast-growing firms that have still not gotten to a big size get a lot more upside on the prices of the shares than those people who keep on waiting to purchase the shares until the firms have grown into behemoths. But penny stocks are usually never the bargains that initially appear to the novice investor. The shares are priced so cheaply for some valid reasons. The abilities of the penny stock firms are unproven and do not have many chances for long-term success.

The penny stocks are instruments by which many fraudulent activities take place on new investors. The investors of penny stocks often think that a low share price shows that the firm has a better potential to grow than the firms with higher prices on their shares. But the valuation of a firm's shares or the market capitalization is hinged on a couple of factors. These include the price of the shares and the number of outstanding shares. The latter is very important because the number of shares issued is completely up to the firm. A hundred shares outstanding at ten dollars per share is exactly as much as a thousand shares outstanding at one dollar per share. Also, the firm with a share price of ten dollars may have a much larger potential for growth than the firm with a single dollar share price.

The authorities who regulate the financial markets know that the penny stocks are very enticing for several investors. Thus, they clearly list penny stocks and their risks. It is possible to lose money with any investment in the share market. But the risk of complete loss of share value is far more in penny stocks. The US Securities and Exchange Commission says, "Investors in penny stocks should be prepared for the possibility that they may lose their whole investment."

What are Penny Stocks' Risks?

The penny stocks come with many risks compared to the ordinary shares in the financial markets. One of the risks is that the penny stock firms are very small. A majority of the firms that are publicly traded are big firms that have clearly shown their value. The value usually ranges between hundreds of millions of dollars or more. But the firms that give penny stocks are usually small. Even the biggest penny stock firms are valued below ninety million dollars. Another thing is that the penny stock firms have not proved themselves yet. It is not usual for firms you have already seen in your regular life to be among those listed as penny stock firms. The penny stock firms are the less established businesses that have not yet proved that they can endure and succeed in the market. The penny tock firms also do not trade on any main stock exchanges. The penny stock firms are not listed by the NASDAQ Stock Market or the New York Stock Exchange.

These penny stocks are usually traded over the counter. The firms who share trade in the over-the-counter market do not have to comply with the stricter reporting requirements necessary for the NASDAQ and the New York Stock Exchange. The proper selling and purchasing of the shares of penny stocks can be quite complicated because the shares that are not so frequently traded are also not so liquid. This means a wide gap between the ask and bid prices. Finally, the penny stock is also the target of many fraudulent schemes. Many fraudsters often aim at these penny stock investors by advancing a penny stock firm as the next big thing. They create hype around the penny stock to increase the price of its shares. The increase in the prices of the shares can be seen as some evidence of the success of the firm. After the increase in the price of the shares, the fraudsters then sell their part of the shares for gains and stock the promotion of the shares.

After that, the prices of the penny stocks decline in a drastic manner. This causes huge losses for the investors who arrive late on the scene and buy the shares at a high price while keeping their belief in the hype.

What are Penny Stocks' Investment Precautions?

You may be an investor still interested in investing in penny stocks after learning about all the risks entailed in the investment. Then, there are some precautions you must take to protect your share portfolio. The first step is to find out the maximum amount of money you are ready to lose in the investment. Calculate how much money you can set aside and then restrict yourself to investing only that amount of cash. In this manner, even if the investment does not go your way, as happens in a majority of the cases involving penny stocks, you will not face any major financial issues. Another thing is to avoid commissions when you transact for penny stocks. Choose a brokerage firm that will not charge any trading commissions on investing in penny stocks. There are several brokers that have removed their commissions on such stock trades. But there are still special fees or commissions levied by a few brokers for purchasing shares below a specific mark.

Finally, try to get another opinion. You must do your own independent analysis of the penny stock firm you want to invest in. There are times when the investor relies only on the information from the firm itself or from people who are promoting these penny stocks. This leaves many victims of fraud. You may not be able to get any data from reliable sources. That is a red light that you may be looking at a fraudulent scheme.

Conclusion

Before this article, you may have been confused about penny stocks. We hope that we have assisted you in clearing all your doubts regarding the same. Several firms on the over-the-counter market are of good quality. There are also other small firms with penny stocks striving hard to climb their way up the ladder to the New York Stock Exchange and the NASDAQ Stock Market. But there are also other great shares on the market that are not penny stocks. Penny stocks are not completely bad. But you have to consider it an investment that entails high risk and is not good for all types of investors. But if you are hell-bent on investing in some penny stocks, ensure that you undertake complete research regarding the same and know what penny stocks and their risks are.