Although the stock market is generally designed as a mechanism for long-term wealth generation, it’s also the home of speculators in search of a quick buck — and penny stocks draw their share of attention from speculative investors.
Penny stocks are low-priced shares of small companies that generally trade below $5 per share, and often in the cents-per-share range — hence the name. But can you get rich off of penny stocks? There’s a chance, if you can handle the risk.
Can You Get Rich Buying Penny Stocks?
It’s not impossible, but it’s unlikely that you’d get rich off of penny stocks. These cheap stocks come with high risk, so you’re more likely to lose money.
If you choose the right company at the right time, your investment could see impressive growth — if you buy shares at $1 each, for example, and stock goes up to just $2, your investment will double. But those shares could easily drop to $0.50 or less just as quickly.
How Do Penny Stocks Work?
If you’re not that familiar with penny stocks, it’s because you won’t often hear of them quoted in the financial press alongside stalwarts like Apple and Microsoft. That’s because they are speculative and rife with fraud.
Shares of penny stocks don’t trade on the national exchanges where all of the big-name stocks trade, like the New York Stock Exchange and Nasdaq. Rather, penny stocks trade “over-the-counter” in places like the OTC Bulletin Board or the OTC Markets Group.
Theoretically, penny stocks are similar to their larger cousins that trade on the NYSE, as they represent ownership in an underlying company. But that’s just about where the similarities end.
Are Penny Stocks Hard To Sell?
Since penny stocks don’t trade on the most liquid public exchanges, they can be harder to sell. One of the benefits of being a big-name stock on an exchange like the New York Stock Exchange is that literally thousands or even tens of thousands of shares can trade hands in a single stock every second, providing immense liquidity.
Penny Stocks Are Illiquid
Penny stocks, on the other hand, can go days without trading even a single share, depending on which penny stock you buy. This type of illiquidity not only means that it can be harder to sell penny stocks, but that there will be a large, built-in spread to the trade.
For example, you might want to sell your penny stock for $1 per share, but there might be no buyers at that price for days or weeks. If you really want to unload your shares, you might have to sell them to a buyer that is bidding just 50 cents per share. Illiquid markets like the OTC Bulletin Board are more costly for investors.
How Risky Is a Penny Stock?
Just based on their illiquidity, penny stocks are risky. However, the whole over-the-counter market is also rife with fraud, as it is an unregulated market.
Unlike companies on the NYSE, which must provide thorough and ongoing reports as to their financial condition, penny stocks have no such requirement. This makes them subject to fraudsters and tipsters on online message boards and even in corporate meetings who promote false or misleading claims about the companies behind penny stocks, hoping to pump up their share prices.
But when the time is right, these promoters are the first ones to sell their shares, taking profits and driving the stock down for those who aren’t quick enough to react. In other words, it’s hard to get information about penny stock companies, and it’s entirely possible you could lose your entire investment.
Can You Become a Millionaire From Penny Stocks?
Of course, it is possible that you can become a millionaire from penny stocks, but you’ll have to be extremely lucky or have access to information ahead of when general investors hear it. Once in a while, you’ll hear news stories about someone who has scored big from penny stocks, but those individuals are by far the exception rather than the rule.
News stories just aren’t as exciting when they are about countless investors losing their shirts in an unregulated market.
Who Got Rich Off Penny Stocks?
There are cited examples of individuals who did get rich off penny stocks. In 2013, for example, CNN Business first reported about Tim Grittani, who turned $1,500 into more than $1 million off penny stocks at the age of 24. He has since turned his trading style into a business, becoming a public speaker and offering tips to investors online.
But Grittani will be the first to tell you that trading penny stocks is a risky strategy that is not for everyone.
The Bottom Line
Although it’s exciting to dream about getting rich quick via penny stocks, it’s generally a fool’s errand. When the Securities and Exchange Commission itself comes out with a blanket statement that “investors in penny stocks should be prepared for the possibility that they may lose their whole investment,” you should definitely keep your wits about you.
If you feel you must invest in penny stocks, speak with a financial advisor who understands your risk tolerance and can help prevent you from trading yourself into oblivion.
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