Why Are Penny Stocks Bad? (Risks and Avoidance Strategies)

Why are penny stocks bad? The internet is flooded with arguments and courses on how to get rich in penny stocks. Hence, penny stocks attract a lot of attention, both among investors and traders, but also among scammers, unfortunately. The traps in penny stocks are many, and we recommend staying away from penny stocks. These stocks are not a way to get rich. They are more likely to send you to the poorhouse.

Penny stocks are bad because many of the companies have unproven business models, they are illiquid, they are exposed to scammers, and they are very volatile. Most penny stocks end up worthless. It’s very difficult to find consistently profitable penny stock strategies.

Penny Stocks are touted as the holy grail in trading for people with less money to get rich quickly. Unfortunately, the reality is that most traders lose a lot of on them.

Penny stocks: Extremely inexpensive equities that are worth substantially less than what they cost.

– Don Staricka

What are penny stocks?

Despite their name, penny stocks do not always trade in pennies, sometimes in dollars: The American SEC uses a much wider definition: any stock below 5 USD is a penny stock. There is no exact definition, but the majority of them don’t trade on any formal stock exchange like NYSE or Nasdaq:

Where are penny stocks traded?

Penny stocks are traded on all US exchanges, but the great majority of them are on the over-the-counter (OTC) and the private Pink Sheets. The Pink Sheets is a private company that offers a listing service for stocks that trade over-the-counter. OTC stocks are simply stocks that are not listed on a formal exchange like NYSE or Nasdaq. The OTC market is being served by a network of broker-dealers to make a market. The whole purpose of the OTC market is to serve as a marketplace for small companies to bring together business ideas and investors for those companies which can’t make it to the exchanges or don’t want to.

Why do companies trade on the OTC markets and not on any exchange?

Both the New York Stock Exchange and Nasdaq are stock exchanges, and have strict requirements to get listed. Very few companies can comply with the exchanges’ requirements as it’s expensive. A rare few companies elect to stay on the OTC rather than the exchanges, but they are the exception.

Why trade penny stocks?

Most people are drawn to penny stocks because they dream of striking it rich.

This is of course unlikely to happen. Trad