Penny stock risks

If you are thinking of buying penny stocks, knowing the risks of these types of stocks is critical. If you don't know the risks, chances are you will lose money since you're basically gambling. And when it comes to gambling, the house usually wins most of the time.

Here's some factors that can influence (or increase) the risks of penny stocks that you may not find in stocks that trade at higher prices:

The stock exchange

Is the stock listed on one of the exchanges? Buying a stock on one of the exchanges is less risky than trading stocks over-the-counter. In other words, it's much easier for "sketchy" or questionable companies to get listed through OTC pink sheets than the three major exchanges. The NYSE, NASDAQ and AMEX all have tougher requirements in place to get listed, as well as rules for financial reporting and market capitalization, among others. Any company that falls out of compliance is booted off the exchange if not brought back into compliance.

Trading volume

How much trading volume is there each day? If not many shares are traded in the particular stock, this can make buying and selling the stock at a market price very difficult and can increase the risk of losses. This can be a risk of higher priced stocks as well, but it is not as pronounced. This is sometimes called "liquidity risk".

Stock price

Why is the stock a penny stock in the first place? The price of the stock itself is important, because many times the reason a stock is trading for such a low price is the company itself may be having financial problems or other issues. The company may even be on the verge of bankruptcy. Can you be sure the company isn't going to fold the day after you buy the stock?

Volatility

Is there much historical volatility? And what I mean by this, is if you look at a 1 year chart for the stock does it make big price moves often, either up or down? While volatility can be your friend, it can also be your worst enemy. Imagine buying a stock for $1.00 a share, and having it fall to .30 cents in just a few days. That's a big loss, especially if you've put a lot of money in one stock.

News, information and research

Since the bulk of penny stocks tend to be smaller, lesser known companies, it's sometimes hard to find any information about these companies. The company may rarely (if ever) release news about company developments, it's products or general business conditions. This makes it very diffuclt to do research or decide if it's a company worth buying stock in. And this increases risk.

Location of the company

Given all these other factors, one additional thing to consider is where is the company located? Since the US, Canada and the UK tend to have more securities laws and regulation in place to discourage fraud, corruption and other unethical business practices, other countries may not, or if they do they may be loosely enforced. Buying stock in a small, unknown company in the US may be risky enough, but buying stock in a small, unknown company in Russia or some other country that may not be subject to the business or securities laws of your country can increase the risks exponentially. And just to be clear here I am not picking on Russia, I love Russia and I love Russians, they are some of the smartest business people out there - I only use this as an example to make a point.

What do I think?

Overall I think penny stocks carry higher than average risk, so I would not invest a lot of money in these types of stocks. However, if you are a person who is interested in penny stocks and think they are worth considering, please check back soon as I will be adding more detailed information on how to find and screen the better penny stocks, which can at least reduce your risks as much as possible.

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