Are Penny Stocks Really High-risk Investments?

It can be hard to gauge the full size of the global stock market, but there are currently 16 separate stock exchanges in the world that boast a market capitalisation value of over $1trillion each.

The global stock market is also incredibly diverse, from small, mid and large-cap entities to potentially undervalued assets in the form of penny stocks.

But what exactly are penny stocks, and do they represent high-risk investments in the digital age?

What is a Penny Stock?

Successful companies aren’t born, but made and grown over an extended period of time. As a result of this, many startups emerge as small-cap or penny stocks that have the potential for immense growth over time.

In the case of penny stocks, this type of asset is classed as high-risk securities with relatively small market cap values and tend to trade at disproportionately low prices outside of major market exchanges.

The latter point is interesting, as most penny stocks don’t actually trade on the major market exchanges or indexes such as the S&P 500. While there are some large companies, based on their market cap, that currently trade below $5 per share on exchanges such Nasdaq, it’s rare to see such assets on the most prominent indexes.

The reason for this is simple; as they typically represent new companies that have a lack of history and financial information, while their relatively low levels of liquidity also make them harder to find and track on a daily basis.

The Risk-Reward Balance with Penny Stocks

Ultimately, the lack of presence and liquidity that defines penny stocks makes them less appealing to most investors, as these factors make them incredibly hard to sell in real-time and potentially volatile on a day-to-day basis.

Of course, these factors also translate into an increased level of risk, which provides a fascinating counterbalance to a penny stock’s accessibility and low price point.

Another key risk associated with penny stocks is that they’re often used to scam potential investors, with so-called “microcap fraud” (which targets low-priced assets and promises huge returns in a bid to wow interested investors) common in markets across the globe.

On the flip side, penny stocks are inherently affordable and do occasionally take off and experience rapid growth. Remember, blue-chip stocks like Amazon would have started out life as small-cap or penny stock assets, with this equity now one of the most valuable entities of its type in the market.

In this respect, the key to successful penny stock investment lies with doing your due diligence and understanding how the market works, while taking a detailed look at the company in question fundamentals and whether they can sustain the requisite growth in the future.

Such an approach can help to minimise risk and exposure in the market, but this remains an asset class that isn’t necessarily suitable for casual, novice or risk-averse investors.