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Individuals
new to investing in penny (micro-cap) stocks should realize
the difference between penny stocks and the more conventional
blue-chip investments, like a Microsoft or General Electric.
There
is no universal definition of a penny stock, as some define
it as a stock priced under a dollar where as others believe
five dollars to be the benchmark. The Securities Division
considers a “penny stock” defined if it trades
at or under $5.00 per share and trades on the pink sheets
or on the NASDAQ/OTC. A true penny stock will have less than
$4 million in net tangible assets and will not have a significant
operating history.
Penny
stocks are traded in the over-the-counter (OTC) market. The
OTC market includes the OTC Bulletin Board (OTCBB) and the
Pink Sheets (a name derived for the color of the paper in
which they are printed on). Investors tend to see much greater
price volatility amongst companies in the OTC market. Most
companies lack a stable stock valuation and consistent demand
for their stock (liquidity). Price volatility and lack of
a reliable exit strategy in the case that an investment plummets
can bring fear to some investors, where as others realize
that one good pick could provide an ROI (return on investment)
hundreds of times greater than on any larger market investment.
Many
penny stock companies start out raising money through an initial
stock offering or a private placement in an effort to develop
products or services or fund an exploration. Though very rare
relative to the thousands of companies on the OTC, if a company
succeeds in utilizing it’s capital correctly (though
many factors can temporarily drive stock price), a company’s
value could skyrocket in a relatively short period of time
and make an investor extremely wealthy. Be advised that proper
due diligence is necessary in any investment decision, but
especially when investing in penny stocks.
Overall,
there is much more risk in investing in penny stocks compared
to securities like blue chips, treasury bonds, or defensive
stocks- but in a diversified portfolio, investments in penny
stocks add a potential for huge gains with a typically small
up-front investment.
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