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Editor’s Note: This is a guest post submitted by Cesar Zambrano
In recent years, one of the fastest growing sectors of the equity market in terms of excitement and investor interest has been penny stocks. By standard definition, penny stocks refer to shares in a company which trade for under $5.00, but most penny stock traders tend to focus on companies that are trading for under $1 per share or even as low as fractions of a penny per share. Penny stock companies also tend to have market capitalization of less than $50 million.
As stated, one of the primary reasons traders are attracted to the world of penny stocks is because of the wild volatility that tends to characterize a penny stock’s price movement each day. Let’s put it into perspective. A medium or large cap stock may move just 1%-2% in a day, and that movement would be considered decent. Many days these stocks may not even move 1%. Now compare that with a penny stock, which has the capability of moving over 100% in a single day!
This is why penny stocks tend to attract traders who are seeking increased market volatility. A wider trading range and increased intraday volatility means there is greater opportunity for potential profit, but [and many traders do not truly take this into account] it is also means there is a greatly increased opportunity for the loss of funds. Furthermore, not only is the chance of losing significant, but losses can often be very quick and sharp.
The potential for substantial movement, both positive and negative, in a penny stock is also much more significant than in a medium or large cap stock. For example, a larger stock such as Microsoft is most likely not going to increase 100% in a year. In fact, that is nearly impossible. The reality is that Microsoft may increase only 10% or 20% in a solid year. A penny stock, on the other hand, has the potential to move that much in a few minutes!Furthermore, if a penny stock company really takes off and finds strong market share for its product and gains traction, then its stock could literally increase 10 fold or more in a year. Conversely, Microsoft is most likely not going to go bankrupt this year. In fact, the probability of Microsoft going bankrupt this year is pretty close to 0%. Penny stocks, however, can go bankrupt in a single day, oftentimes without the slightest clue, due to inefficient business practices, mismanagement, fraud, and a host of other causes.As you can see, penny stocks are a high risk high reward investment vehicle. Unfortunately, many scam artists and fraudulent companies are attracted to the penny stock world because of this reason. Therefore, there tends to be heavy price manipulation and rampant fraud in penny stocks. Some companies will engage in “pump and dump” schemes, which basically means a company will spread incredibly falsified and exaggerated claims about a company regarding its products, financials, and market share.Then, they will take positions in the company’s stock before they spread the lies, and as the lies spread, investors begin falling prey to the scam and start buying the penny stocks. Soon, investors see the price rising substantially, and in fear of missing a golden opportunity, they jump in the market. Finally, the original investors will sell all of their shares and make millions of dollars, while the rest of the investors are left holding the stock of a worthless company.The penny stock world is full of upside potential, but it is also fraught with high risk, so make sure you always conduct extensive research before investing in a penny stock company. Some forex brokers offer charting packages for equities, where a trader can track penny stock movements.
Note from Sherin Dev: This guest article deals with Penny Stock which myself considers as high risk investment. Any action from the readers on this article should be taken at their own risk. To know more about Sherin’s successful investment practices and stories, follow me in Twitter or Facebook
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