The Dangers Of Penny Stocks

The Dangers Of Penny Stocks

The Dangers Of Penny Stocks


Penny stocks rose to prominent fame few years ago, when people started admiring them for they require less money as investment. However, with time, there was a realization that penny stocks are not as good as they seem to be and there are several dangers of buying these stocks. 


Since penny stocks are difficult to trade and pose a lot of threat to those who have it, we thought that today, we are going to do a write up on the dangers of penny stocks to brief our readers as to what to expect before they invest in them.


Penny stocks can be a dream or nightmare for anyone but there are more risks associated with it than benefits. According to some experts, these stocks should be avoided for the reasons given below.


Less Transparency


The fundamental reason why penny stocks are considered dangerous is because they have less stringent requirements as far as governance, transparency and assets are concerned. As compared to other financial instruments, these are less regulated. 


It is known about penny stocks that they are usually traded on over the counter markets or pink sheets. The level of transparency that they have can differ from market to market. We have even seen cases of no transparency for these stocks. The companies that deal in penny stocks also do not have any such governance or quality. Companies with absolutely no assets or revenues have sold these stocks. Therefore, if one isn’t mindful, it is quite possible to get sucked into buying something completely useless. 


Since there is no such transparency in penny stocks, there are too many dangers associated with them. The credibility of what you are getting and the chances of you getting scammed are quite high in penny stocks. Therefore, penny stocks come with the dangers of transparency and quality and should be watched with a keen eye. Most people are not aware of the transparency problem with penny stocks, hence, this is something that must be duly considered before investing in them.


Small Companies, Higher Chances Of Mismanagement


What is also commonly known about penny stocks is that they are usually traded by or owned by small companies and such companies have less eyes prying on them. Therefore, the chances of mismanagement are high. There are also chances regarding conflict of interest within the companies that trade penny stocks and therefore, it is a big underlying threat for these companies. If you have chosen a company that might be struggling with this issue at the back end, you are going to be at the struggling end of it all.

Reverse Mergers


One of the biggest concerns regarding penny stocks is that these companies are usually dealt with by small companies and a lot of these companies end up going out of business. Therefore, there is an automatic risk involved for those who buy these stocks. Since these are not subjected to the SEC reporting requirements, nobody knows how well a company, which they invested their money in, is doing or how it will do in the coming run. If a penny stock company that is trading publically fails, it can transfer to a new company through what is referred to as a reverse merger. This reverse merger is done through a legal trading shell but nonetheless, it is complicated and it poses a lot of dangers for the investors. Reverse mergers help private companies to go public easily. Reverse merger itself has a lot of threats for the investors, as it can create many large blocks of stock that are held by people who try to dump the shares, all of them, in the market to get their profits which ends up causing a decline in the price of the stocks. 


Liquidity Concerns


Another major danger of penny stocks is the concern of liquidity. These stocks usually trade sporadically. When these stocks are traded on the higher exchanges, they are thinly traded and it causes a common concern as to who will buy them. For penny stocks, there is no market per se as only a few brokerage firms allow the customers to trade these stocks. Penny stocks are also very speculative and therefore, traders react to news related to stocks that fuel speculation. When there is good news, there is a hot buying period but when there is no news or bad news, there comes a huge lag in these stocks. People therefore, might be stuck and they might not be able to sell the stock when they want. This brings up the whole issue of liquidity concerns amongst these stocks and the proposition to never invest in these stocks if you don’t have that kind of money or money that you cannot afford to lose.


Scams Related to Mining


Oil, diamonds and gold have always allured people. However, they are not devoid of scams or come with a guarantee that there will be no scams associated with them. In the mid 1990s, there was a mining scam called Bre-X, when David Walsh, the founder of the company, falsely claimed that his company had found a huge gold mine in Burma. Due to the speculation that rose immensely fast, the company’s valuation, all which was in penny stocks, became $4.4 billion by 1997. However, when the company collapsed, most of the investors lost pretty much every thing. Penny stocks are, therefore, volatile and they are not dependent on actual events or news to grow. Some scams or general speculation, created by people themselves, can send the prices of these stocks soaring or plunging. You might, therefore, not know what exactly you might be getting into with these stocks.


Thus, to conclude, I rest my case by saying penny stocks are a no go for those who do not understand how tricky, volatile and unreliable they are. These stocks don’t have a strong backing and might end up troubling those who invest in them by making them lose a lot of money.