Beware of Penny Stocks
If you’ve ever watched the movie Boiler Room, you seen what people can do with penny stocks. Most experts and investment advisors tell their clients to be wary of penny stocks because they are often used to defraud investors. It is a highly risky investment strategy to use.
What they do is set up a fake company. Then they issue false documents and issue and IPO. They make up some back story of how it’s going to grow to be the next Microsoft or Google and people can get in on the ground floor.
This strategy often works because the stocks are so cheap and it’s one of a few options for finding small investments. Although the official definition of a penny stock according to the SEC is less than $5 a share, often you can find them for $1-2 a share. The cheapness of the stock and the potential to make exponentially large returns, even should it rise to a measly $8 a share is irresistible to some.
The main problem with these stocks is that they go under the radar. They are too small for anyone to really care about. And they often have very little information about them that you can find in the public domain. Unless you know the people running the company first had, it is often difficult to determine if they are a legitimate company.
Even if they are a legitimate company, you might get stuck with the stocks if you buy them. Penny stocks usually have very low liquidity. That means there isn’t much trading volume on any given day. That means if you want to sell your stocks, you may not be able to find a buyer. That might be a problem if you are trying to unload as quickly as possible.
If you do develop a strategy of buying penny stocks, because there are legitimate ones out there, I would consider diversifying across many different stocks. If you invest in 5 different penny stocks, it is unlikely that all of them will be fraudulent or a bad buy. In any case, you should be very cautious.
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