Penny Stocks

Introduction

What is a penny stock? Well, as it turns out, there isn’t really a set definition for it (sorry). A commonly accepted definition, and one that I think works well, is any stock that costs less than $5/share. Seems simple enough. Why am I spending an entire article covering them, you may ask? To tell you not to buy them. The low price makes them very attractive, especially for people who don’t have much money to invest, but there are about an infinite number of reasons why you shouldn’t buy them. Let’s cover a few.

Company Quality

Why would a stock cost so little? Perhaps the biggest reason is that the company is not performing well, so no one wants to buy the stock. Often, the company will be near bankruptcy. You definitely don’t want to be buying stock from a company that will soon not exist.

Volatility

An interesting webpage to study is the Top Gainers and Top Losers page on Yahoo Finance. Here you will see the stocks that have increased and decreased the most in the day percentage-wise. If you look at them enough you’ll see a pattern: Both lists are constantly topped by penny stocks. Penny stocks are extremely volatile, meaning their price changes rapidly. One day they may climb 30% only to drop 50% the next, and there’s not really a good way to predict when it will happen. My suggestion: Don’t take the risk.

Liquidity

When we’re talking finance, liquidity comes up a lot. It means the ease at which you can sell something. Here, we’re talking about how easily you can sell a stock once you buy it. For big companies, this isn’t a problem. People will trade tens of millions of shares a day, and it will be very easy for you to slip your sale into that mosh pit. However, for penny stocks, which are often from very small and unknown companies, the volume is very small (volume is how many shares are traded in a day), meaning not many people will be able to buy your stock. If you buy it, you may not be able to sell it, which is not good if the stock starts dropping.

Conclusion

I have about a hundred more reasons listed as to why you shouldn’t buy penny stocks, but I think you get the point. However, you may be left with a question. If I only have enough money to buy penny stocks, and not enough for the large, well-established companies, what should I do? Worry not. Your investing journey will not end before it has even started. Fractional shares will allow you to buy stock from large companies no matter how much money you have. Check out my article on them here. And remember. If it’s less than five, do not buy (I’ll count that as a rhyme).