What are Penny Stocks?
It is not true that penny stocks cost one penny to buy. Penny stocks or penny shares refer to shares that are speculative in nature because of their low value. There are different criteria used by financial analysts to define a stock as a penny stock. Some analysts use the market capitalisation of less than 100 million pounds while others use the price of a share from 50p to 3pounds as a definition of a penny share.
Whatever criteria an analyst uses to describe a penny stock, the bottom line is that these companies will have a small amount of net tangible assets and a very short history. Because of this, penny stocks are very speculative and volatile which makes them both exciting trading prospects or very risky.
If penny stocks are so risky, why would anyone trade in them? The main reason to trade in penny shares is the profits one can make. If a blue chip company were to increase in value by 50p, it would not make a big difference in your profits. However, a penny stock you bought at 50p increasing in value by 50p will give you 100% profits.
Trading is penny stocks is not for everybody. The chances of a penny stock doing well are slim especially in the present market. If you believe in the product or service that a company offers or think it is going to be an emerging market, then you may consider investing in penny stock.
If you are still new in the stock market or have limited stock trading capital, you should avoid trading in penny stocks. Borrowing money to trade in penny shares is a sure way to lose money. Penny stocks are for the informed investor and you should take your time and do a lot of research before investing in them.
In the UK, the Alternative Investment Market (AIM) created in 1995 to gives small and young companies access to public financing. This is the main market where you can trade in penny shares before they are listed in the London Stock Exchange (LSE). The LSE also allows penny shares if they have a 3-year operating history and have 25% of their shares held by the public.
The Off Exchange (OFEX) is another market where you can trade in penny shares. The OFEX is not a regulated market and new traders should avoid it. Most penny shares are biotechnology companies, internet companies and very new share issues. The risk is high but the rewards for penny stocks can be huge.
Because of the volatility of penny stocks many online companies have created newsletters that they sell to investors, which they claim, have the best penny stocks. Some of these online companies are pure frauds and new investors should avoid them. However, some research companies have proved over the years that they can make profitable stock choices to the benefit of their members.
It is up to the individual investor to do due diligence to find out if penny stocks are good for them. Otherwise, new investors are encouraged to avoid penny shares until they are properly capitalised and have done good research.