The promise of penny stocks often is touted as a way to turn small investments into large windfalls, with little or no mention of the risks that go along with these ventures. As with most investments where the rewards are high, the odds of making money in penny stocks are very low, but there are measures that can be taken that can improve the chance of success.
A Quick Primer on Penny Stocks
Penny stocks, also referred to as micro-caps, are defined as shares of companies that don't trade on major exchanges such as the NYSE, NASDAQ or the AMEX; typically, such shares are priced under $5. Penny stocks trade on either the Over the Counter Bulletin Board, referred to as OTCBB in print, or on the Pink Sheets, primarily because they don't meet the capital and reporting requirements necessary for listing on the on the major exchanges. Generally speaking, penny stocks trade on "over the counter" markets either because they're at a very early stage of development or have been delisted from major exchanges for failure to maintain capital requirements.
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The Key Difference Between OTCBB and Pink Sheets
The key difference between these two markets is that companies quoted on the OTCBB are required to file current financial reports with the Securities and Exchange Commission, following the same protocols as listed companies, while companies trading on the Pink Sheets have no such requirement. For investors, the requirement to report earnings on a quarterly basis provides companies listed on the OTCBB a significant advantage over those trading stocks on the Pink Sheets as earnings reports can provide regular snapshots of each company's progress and financial condition. Companies that trade on the Pink Sheets, on the other hand, can trade for years without releasing information of any kind.
Increasing the Odds of Penny Stock Success
The steps that can increase the chances of successfully investing in penny stocks are much the same as buying stocks on the major exchanges, including assessments of the prospective companies' financials, products and services and conducting due diligence. Additionally, the best way to improve the odds of success with penny stocks is to limit investments to stocks trading on the OTCBB. Limiting your investments to companies with transparent reporting provides a boost when it comes to picking winners, versus the "hot tip" nature of Pink Sheet stocks.
Increasing the odds of success when buying penny stocks doesn't make them safe investments, as the OTCBB and the Pink Sheets can serve as either the spawning or burial ground for speculative companies. Managing risk in the high-risk environment of investing in penny stocks requires extra care and research before making an investment, and only a small percentage of a financial portfolio should be allocated to this category; losses, much like high-stakes betting in Las Vegas, can be frequent and precipitous.