I’m seeing more online about penny stocks and quite a few responses/advice from others to avoid them. What’s the biggest risk involved with them -vs- higher priced, more established stocks ?
Penny stocks can have excellent returns (in the tripple digits) in a very short time period. However, these stocks can also fall much faster and further.
I have gotten great returns on penny stocks but only when I avoid putting all my eggs in one basket. What I do is invest in equal proportions in several penny stocks that I like. This way if I loose close to 100% in one stock this is more than offset by the several hundred percent gain on other stocks.
Penny stocks are less liquid which means that even if you have a great paper gain you might have a tough time realizing said gain. This is your order sometime could take a while to execute and ultimatly execute at worse conditions than you would get on a more liquid share.
As a general rule stocks don’t IPO as penny stocks, in other words the stock has fallen since its offering. If you look at penny stocks as a value investor and analyze them as you would analyze value stocks you will usually find severely over sold stocks. These are the gold mines, however sometimes there is a reason why a stock has become a penny stock and you could get burned on those. (Hence the importance of research and diversification)
The biggest risk I have seen investing in penny stocks is that their valuation is often highly dependant on news flow. Sometimes there is are union negotiations, FDA approval, new product launches which can make or break a company. Unless you have material non-public information (insider trading) it can be quite difficult to know if this particular stock is going to shoot up 3 digits tomorrow or if the company is about to disappear.