Most physician investors have heard the adage buy low and sell high. It still rings true and is often touted in investing circles. Well, you can’t get much lower than penny stocks. So, if that’s the case, what is there to lose? The answer is plenty if you’re not careful.
As shared on Investopedia, according to the definition developed by the U.S. Securities and Exchange Commission (SEC), a penny stock is a share in a small company that trades for less than $5. Although you can find a few penny stocks being traded on established exchanges such as the New York Stock Exchange (NYSE), most trade through over-the-counter (OTC) transactions using the electronic OTC Bulletin Board (OTCBB).
Since these stocks trade at such a low price, there is the tempting possibility of high gains. As with most investing endeavors, the potential of high rewards comes with high risk. Penny stocks are notoriously volatile. You are buying into small companies that often have little cushion on their spreadsheets to weather adversity. And that’s if you even get to see a spreadsheet.
Another issue that physician investors should consider when exploring penny stocks is the lack of information available on them. When a stock trades on one of the large exchanges, there are standards they have to reach and regulations they need to adhere to in order to be actively traded. On the OTCBB, that is not the case, as no minimum standards are required to participate. So, often when you buy a penny stock, you don’t have enough information to evaluate it, and you have no regulatory guard rails to ensure the company meets certain standards.
This can, unfortunately, provide a veritable breeding ground for fraud. If you have no way of researching a company, then you have no way of knowing if it is legitimate or if it just a shell corporation drawing funds to scam unsuspecting investors out of their hard-earned cash.
It is important to note that not all penny stocks are bad. Some are legitimate companies that are just starting out and have viable products or services to offer. They may or may not be able to find success. By investing in them, you can either help them reach that success or you can lose your investment in the effort.
As with all risky investments, the best way to approach penny stocks is to gather as much information as you can and protect yourself from overextending. Beware of brokers pushing penny stocks that are guaranteed to hit it big. And, as always, consult a trusted financial advisor with your questions.