Penny stocks TOPIC: RISK

Autore: Beatrisa Pucalev, Asset Management, Risk Senior Associate

Trading penny stocks is an attractive deal but also an extremely risky strategy.

Penny stocks trade for less than £1 on UK stock exchanges or less than $5 on US stock exchanges. The low share price means the stock is likely to be a highly speculative investment.

Investors are easily attracted to penny stocks given the opportunity to make huge percentage gains in a short period of time. As a matter of fact, penny stocks can be extremely volatile from day to day, enabling investors to literally double their money overnight.

The low share price and ability to reap massive gains in a short time is appealing on the surface but don’t be fooled! There are many dangers out there: firstly, these stocks are traded OTC thus there is often a lack of legitimate financial information; secondly penny stocks are illiquid, so it is hard to find a counterparty. However, the greatest danger of investing in penny stocks is the frequent occurrence of illegal “Pump and Dump” schemes.

A Pump and Dump occurs when an investor heavily promote a stock they are holding like “the next big thing,” along with hyped details of an upcoming news announcement that will “send the stock through the roof.” Think about The Wolf Of Wall Street movie and you got the right idea. Then after the stock price has risen the very same investor sells immediately and behind the hype walks away with a big gain. However, the unsuspecting investor who bought the promoted stock is now left holding a losing stock that has fallen in price due to this illegal act.

Cheap stocks are cheap for a reason!