Penny Stocks and the Risk Reward Ratio

As You Prepare to Make Your Fortune in Penny Stocks, Make Double Sure You Know the Risks:

This from Investorpedia:

What makes penny stocks risky?

Four major factors make these securities riskier than blue chip stocks.

1. Lack of Information Available to the PublicThe key to any successful investment strategy is acquiring enough tangible information to make informed decisions. For micro-cap stocks, information is much more difficult to find. Companies listed on the pink sheets are not required to file with the Securities and Exchange Commission (SEC) and are thus not as publicly scrutinized or regulated as the stocks represented on the New York Stock Exchange and the Nasdaq. Furthermore, much of the information available about micro-cap stocks is not from credible sources.

2. No Minimum Standards
Stocks on the OTCBB and pink sheets do not have to fulfill minimum standard requirements to remain on the exchange. Sometimes, this is why the stock is on one of these exchanges. Once a company can no longer maintain its position on one of the major exchanges, the company moves to one of these smaller exchanges. While the OTCBB does require companies to file timely documents with the SEC, the pink sheets have no such requirement. Minimum standards act as a safety cushion for some investors and as a benchmark for some companies.

3. Lack of History
Many of the companies considered to be micro-cap stocks are either newly formed or approaching bankruptcy. These companies will generally have poor track records or none at all. As you can imagine, this lack of historical information makes it difficult to determine a stock’s potential.

4. Liquidity
When stocks don’t have much liquidity, two problems arise: first, there is the possibility that you won’t be able to sell the stock. If there is a low level of liquidity, it may be hard to find a buyer for a particular stock, and you may be required to lower your price until it is considered attractive to another buyer. Second, low liquidity levels provide opportunities for some traders to manipulate stock prices, which is done in many different ways – the easiest is to buy large amounts of stock, hype it up and then sell it after other investors find it attractive (also known as pump and dump).