The Pros and Cons of Investing in Penny Stocks

From the heading of this article you can probably surmise at least one potential benefit of investing in penny stocks: they're cheap! In fact, any stock that trades at less than a dollar a share falls into this category. Despite that, however, they are considered to be extremely risky and volatiles stocks to invest in most of the time, a distinction that doesn't really jibe with the low-cost angle. In truth, there are several reasons why you might want to invest in such stock options, along with other facets of the trade that may stay your hand on its way to dialing your broker. Here are just a few you will want to be aware of before you commit a significant amount of funding to such a venture.

The main benefit of this type of stock, aside from the fact that you can purchase thousands of shares for the same amount of money that you might spend on merely dozens or hundreds of more expensive stocks, is that they can move very quickly and earn you a lot of money in the process. Of course, this could also be a decided drawback. On the upside, suppose you purchase 100 shares of a stock that costs $1 per share and it goes up fifty cents the same day. Good news! You just made $50. On the other hand, considering that the price of these stocks can fluctuate widely within any given 24-hour period, you could also lose whatever you invest in no time flat. It's a high-risk situation that has the potential to deliver fast rewards, but you may as well throw the dice on that outcome.

This leads us to the main negative aspect of such investments: because they are so cheap and so volatile, shady investors sometimes try to manipulate the market for their own personal gain. Especially popular is the "pump and dump" ploy in which a particular penny stock is selected by an investor (or group of investors). They buy up tons of shares, issue information that the stock is "hot" (even though they're the ones buying it), artificially inflate demand (and concurrently price), and then dump the stocks, deflating the value but earning a quick buck in the process, at the expense of other investors.

And another problem is that such stocks are rarely traded on reputable exchanges like the NYSE or NASDAQ. In some cases, a large company may fall on hard times and see their stock prices dip into the penny range, but more often than not these stocks come from small public companies and change hands rapidly via over-the-counter trading sites like OTC Bulletin Board (OTCBB) or Pink Sheets (and the latter isn't even regulated by the SEC).

Now, this isn't to say that you can't learn the ins and outs of trading these fast-paced stocks in order to have some fun with your investment funds and potentially see some major returns in a very short amount of time. If you can target the best technology penny stocks you may be able to turn a profit in very little time. But you definitely need to do your homework and take this niche market with a grain of salt. Don't forget it's a gamble.