Penny Stock Basics
Investing is the practice of committing money toward something in the hope that it will yield a return or profit in the future. Stocks are small equity shares in companies that go up and down in value over time according to market demand. If you invest in a stock that increases in value and then sell it, you will make a profit. The term "penny stock" describes stocks that have low share prices.
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What is a Penny Stock?
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There is no exact definition as to what constitutes a penny stock. Some define penny stocks as stocks with share prices less than a dollar, where you must literally use pennies (fractions of a dollar) to buy shares. According to the U.S. Securities and Exchange Commission (SEC), penny stocks often refer to stocks with share prices of $5 or less issued by small, speculative companies, where stock prices are often quoted over-the-counter.
Benefits
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The primary benefit to investing in penny stocks is the potential to make large returns in short periods of time. Well-established companies traded on major stock exchanges, such as Coca-Cola and Microsoft, do not have the same growth potential as small, unproven companies. Small companies can sometimes double or triple in size in less than a year, which can result in large gains in investment value. Small changes in share values of penny stocks can result in large percentage gains. For instance, if you buy shares in a penny stock that costs 10 cents per share and the stock increases to 13 cents per share, you will have made a 30 percent return on your investment.
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Risks
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Like all equity investments, penny stocks can go up or down in value, so there is the potential to gain or lose money. Penny stocks are considered extremely risky since the companies that issue them are often small and unproven. If a company goes out of business, you could lose your entire investment. The SEC warns that penny stocks often trade infrequently, which can make it difficult to sell shares when you want to.
Considerations
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Penny stocks are often the source of investment scams and fraud. Be wary of advertisements that claim massive or guaranteed returns from penny stock investing. Penny stocks can be susceptible to "pump and dump" schemes, where an investor buys up a penny stock, generates interest in the stock through false or misleading statements to generate demand, and then sells the stock when the share prices spike. The SEC states that pump and dumb schemes commonly occur on the Internet, which enables perpetrators to reach large numbers of consumers through advertising and email.
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