A penny stock, or a microcap stock, is usually thought of as a stock trading under $1 a share, though some on Wall Street consider anything under $5 to fit in the category. These assets bring the opportunity to make cash quickly, but they also bring an enormous amount of risk with them. Penny stock picks and microcap stock tips are widely available, but how much should they be trusted? Take a look at some of the reasons an investor should be very careful with these investme, and more specifically penny stock advice.
Easily Manipulated
Penny stocks are easily manipulated because of the market they trade on and the fact they aren't well-known to many investors. These names aren't very liquid at all and they are often moved very easily by a single big trader. This is the classic pump and dump scheme, which is very common in these investments that trade over the. In a pump and dump scam, a trader or group of traders buys a large amount of a stock then hypes the stock via every method they possibly can. Pump and dump schemes are illegal, but they aren't always easy to catch and the over the counter market, or pink sheets, that penny stocks trade on are very easy to manipulate.
Lack of Information
Penny stocks very rarely provide financial information to the public, which makes researching the stock very difficult. Stocks that trade on the pink sheets have no requirements to divulge any kind of information. These speculative investments often offer no hard data for the investor to pour over, rather they simply offer sales pitches and ambiguous answers.
Lack of Liquidity
Penny stocks trade in a market that has very little liquidity. This is dangerous to the individual investor because it can mean getting stuck with shares, or buying a stock that has just been manipulated by a large trade. Liquidity in the market is very important, and small stocks like these very rarely have very much liquidity at all.
Penny Stock Picks Often Not Trustworthy
It is simple to go on the Internet and find plenty of penny stock picks or tips. These are generally found in places like message boards, chat rooms, or blogs. Why shouldn't an investor trust this kind of penny stock advice? Understand that the people making these posts are not trying to help the individual investor find a good stock, rather they are trying to make a profit themselves. They are looking out for number one!
The Bottom Line
Penny stocks do not come without a large amount of risk. As an investor, understand these risks before investing in these types of stocks. Also, please understand that microcap stock recommendations should be taken with a grain of salt. If these stocks seem like a good idea, make sure to do the homework individually and not with the "help" of tips from message boards or other similar sources.
References:"The Lowdown on Penny Stocks" Investopedia Staff. Retrieved September 14, 2009.
"Microcap Stock: A Guide for Investors" SEC. August 2004. Retrieved September 14, 2009.
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