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Penny stocks have been immortalized by movies like ‘Boiler Room’ and ‘Wolf of the Wall Street,’ which allowed them to secure a unique position for investors in America. They have been portrayed as an opportunity for an investor to spend a few hundred dollars with the possibility of reaping thousands of dollars in profit within a short time.
It is true that there have been instances where penny stocks have taken an investor from rags to riches. But unfortunately, these instances have been responsible for generating certain myths about penny stocks that can mislead investors.
People planning to invest in penny stocks should understand that it is not a guaranteed get-rich-quick scheme. These are some of the most dangerous penny stock myths that need to be busted right now.
- Anyone Can Trade With Penny Stocks
- Penny Stocks Are Different From Micro-Caps
- Penny Stocks Can Shoot to the Moon
- Reputable Companies Like Microsoft and Walmart Started as Penny Stocks
- All Shares That Trade Under $5 Are Penny Stocks
- All Securities Sold in the OTC Market Are Penny Stocks
- Institutions Cannot Sell Penny Stocks
Anyone Can Trade With Penny Stocks
Anyone can indeed buy penny stocks since investors can choose from more than 3000 companies that offer their penny stocks on the OTC market. However, people should keep in mind that buying is just half of the stock trading equation.
It may be easy to buy penny stocks, but many investors may face problems when it is time to sell those shares. Most penny stocks tend to be traded quite thinly, so it can take a few days to divest the holdings. A slow settlement can cost an investor a large portion of their paper profits.
In worst-case scenarios, the share value can drop sharply while waiting for a settlement, leaving the investor with a heavy loss. That is why investors must consult professional and reliable sources before buying penny stocks.
Penny Stocks Are Different From Micro-Caps
Some people may find that term “micro-cap” sounds more respectable than penny stocks, but essentially they both describe the same thing. Penny stocks can be defined as low-volume and low-priced stocks that range from pennies up to $5.
These are essentially speculative shares offered by new and small companies without any track record. Stocks for such companies are usually traded in the OTC ( over-the-counter) market because they have minimal reporting standards compared to the bigger stock exchanges.
Investors should know that the SEC also defines micro-cap stocks to be exactly the same thing. They are also shares offered by companies that have declared to have limited assets. Micro-cap stocks are also sold in the OTC market. The SEC also states that companies offering micro-cap shares have less than $6 million in net tangible assets.
However, most of these companies tend to have less than $1.25 million. The SEC is known to keep an eye on companies that offer micro-cap shares because they have the power to suspend trading if they suspect that the company is presenting misleading information.
Penny Stocks Can Shoot to the Moon
People have the notion that companies selling penny stocks would become successful overnight, which will result in their share prices shooting to the moon. As we mentioned before, there have been certain instances when investors have made substantial profits from such incidents.
However, people should generally avoid calls from stockbrokers that claim to offer such shares. Investors should know that reputable companies do not hire salesmen to cold call potential customers to sell their shares.
Moreover, Wall Street research analysts charge a lot of money to sell their research to paying customers, so it is unlikely that someone would give away such valuable information for free. Instead, investors should conduct their own research or consult professionals before investing in penny stocks.
Reputable Companies Like Microsoft and Walmart Started as Penny Stocks
A simple Google search can reveal that Microsoft’s IPO in 1986 sold shares at $25.50, whereas Walmart’s IPO in 1970 priced the shares at $16.50. In fact, most reputable companies tend to get investments from private investors to grow their business till it makes an IPO worthwhile. So, even though some large publicly traded companies started with their shares priced under $1, it is not a common affair.
Most people assume that any stock that trades under $5 can be called a penny stock. However, a stock with a bidding price of less than $5 may not be termed as a penny stock if it can meet the net tangible asset criteria put forth by the SEC. Therefore investors should learn more about the Net Tangible Asset or Average Revenue exemptions before assuming any share priced under $5 as penny stocks.
All Securities Sold in the OTC Market Are Penny Stocks
People should know that the top-tier of OTC markets, also called the OTCQX, does not include penny stocks. Overall, there are almost 3400 companies that trade shares in the OTC market that are not listed as penny stocks. These companies include:
- More than 800 securities that report to the SEC
- Over than 400 banks
- Almost 1900 international securities
Institutions Cannot Sell Penny Stocks
Many people assume that only retail traders can sell penny stocks in the OTC market, and institutions are barred from selling their shares. People believe in this myth because there were restrictions placed on institutions from participating in selling stocks in the OTC market in the past. However, these prohibitions have been lifted now, and institutions can sell penny stocks or larger securities these days.
We hope that we have been able to clarify some of the misconceptions that revolve around penny stocks. Investors should realize that this knowledge is critical to make informed decisions to trade in penny stocks. They should always consult professional stock experts if they have any doubts regarding trading in penny stocks.
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