Penny stocks are popular due to their immense profit potential. Penny stocks do seem like a great way to buy a huge quantity of stock inexpensively. But on the flip side, penny stocks can also turn out to be quite burdensome if you cannot exit the stock whenever you want to.
Yes, you can get stuck in a penny stock. Let’s see how that happens.
How Do You Get Stuck in Penny Stocks?
A high percentage of penny stocks are traded in the over-the-counter (OTC) market. OTC is largely unregulated. This means that many penny stock companies can get away with not publishing their disclosure documents – like their financial returns, press releases, insider transactions, and other important developments.
Scammers lure novice investors into investing in such companies with the promise of easy money. Due to their lack of knowledge, these novice investors usually do not check for disclosure documents of the company (like quarterly and annual reports) which are meant to protect them.
As a result, they sometimes purchase penny stocks blindly, which can turn out to be quite an expensive mistake. Penny stocks are notorious for pump and dump schemes. So once the unsuspecting investor buys the stock, the penny stock’s price would suddenly drop. Most of the time, such stocks would have very low liquidity and there would not be any buyers for the stock. As a result, the investor can potentially get stuck in the penny stock.
Other ways through which penny stock scammers trap unsuspecting investors is through reverse mergers and reverse splits.
Tips to Avoid Getting Stuck in Penny Stocks
Here are the tips for avoiding getting stuck in a penny stock.
Check for Liquidity: Before selecting a stock, make sure that it has enough liquidity. Many penny stocks are thinly traded because only a few brokerage firms let their customers trade penny stocks without much hassle. Many times, after any breaking news, such penny stock does not get traded at all. This can cause you to get stuck with the stock. The best way to avoid this situation is by choosing penny stocks with enough liquidity for trading.
Research fundamentals: Make sure to research a little on the company’s fundamentals before selecting the stock. Never buy into hypes. Instead, do your own research to understand if the company is worth investing in. For instance, if you can’t get accurate cash flow, cash balance, and debt figures of a company, it’s not a smart investment idea.
Learn Technical Analysis: Many times, the upcoming move of a penny stock can be predicted via technical analysis. There are various indicators, overlays, and signals that point to an upcoming price surge, decline, or continuation of the trend. Choosing the stock that shows the probability of an upcoming profitable move can help you avoid losses or getting stuck in the stock.
In addition to these, there are various strategies for spotting a potential pump and dump scheme. These are covered in depth in the professional penny stock course.