Risks and Characteristics of Penny Stock Investing

Equity investments known as “Penny Stocks” are one of the riskiest investments that investors can participate in. Penny stocks are basically any stock that trade outside of the major stock exchanges and trade at prices generally less than $10.00 per share. Investors should be aware that it is possible to lose their entire investment into a penny stock for any number of reasons.

The SEC characterizes a penny stock as a low price speculative security and may or may not trade on a securitized exchange. Many stocks may also be difficult to get updated price information however there are listing services such as the OTCBB and Pink Sheet listing services which today’s average investor can find online. These investments are forms of public financing that generally small startup companies use to grow and expand their business. The regulation of these types of securities is less stringent in terms of financial reporting requirements and minimum capitalization levels.

Factors for investors to consider about penny stocks include a lack of liquidity (ability to sell the shares quickly or at fair prices); relaxed accounting standards, notification of ownership of shares or material changes of fundamental conditions which regulatory bodies design normally to protect shareholders from fraud.

There is the possibility that a Penny Stock investment can reward investors handsomely because the underlying company performs well by responsibly using the investment capital to grow. There are many case examples of large multi-national publicly traded companies who originally began as a Penny Stock, however investors should be aware that this doesn’t happen often and in more cases than not, the exact opposite happens and the stock loses value to eventually trade worthless as the company goes out of business.


Fraudulent practices are more inherent in these types of equity investments. One common scheme known as “pump and dump” refers to instances where a company is publicly touted as a “hot” stock because of favorable financial conditions or a new “hot” selling product or service. This exaggerated hype, causes demand by investors who buy the stock in high volume, which drives the price of the stock higher all while the individuals behind the scheme are selling their shares at this higher price so that when the excitement of the news is over or possibly even untrue the stock price falls drastically and investors lose their money.

Anytime an Investor hears news, research or important information about a company or stock, they have to consider the credibility of the source of that information or what motivations that source may have to release that information.

Other fraudulent schemes which are more common today appear on the Internet, the fax machine or telephone solicitations from individuals to convince investors to invest their money into these low priced instruments with the hopes of large financial rewards that never materialize.

As is the case for any investment vehicle, Investors should take many steps before investing in a penny stock.

The average to novice investor should always talk to a professional financial adviser to determine the suitability with respect to risks associated with the investment and if that investor is prepared to possibly lose their entire investment.

Investors should always investigate the company itself to determine the viability of their product or service, management’s track record, as well as their profitability and financial strength. The marketability and competition for their product or service agent should also fall within the investor’s radar to determine if the investment can hold its value.

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