This disclosure contains additional important information regarding the characteristics and risks associated with the trading of small-cap stocks (“penny stocks”).
What is a "Penny" Stock?
Generally, penny stocks are low-priced shares of small companies. Penny stocks are generally traded over-the-counter and are historically more volatile and less liquid than other equities. For these and other reasons, penny stocks are considered to be speculative investments. Consequently, customers who trade in penny stocks should be prepared for the possibility that they may lose their entire investment, or an amount in excess of their investment if they purchased penny stocks on margin. Before investing in a penny stock, you should thoroughly review the company issuing the penny stock. In addition, you should be aware of certain specific risks associated with trading in penny stocks.
Risks Associated with Penny Stocks
There are a number of risks of trading penny stocks, including the following:
You Can Lose All or Much of Your Investment Trading Penny Stocks. All investments involve risk but penny stocks are among the most risky and are generally not appropriate for investors with a low risk tolerance. Many penny stock companies are new and do not have a proven track record. Some penny stock companies have no assets, operations or revenues. Others have products and services that are still in development or have yet to be tested in the market. For these reasons therefore, penny stock companies have a greater risk of failure and those who invest in penny stocks have a greater risk that they may lose some or all of their investment.
Lack of Publicly Available Information. Most large, publicly-traded companies may file periodic reports with the Regulators that provide information relating to the company's assets, liabilities and performance over time. In addition, these companies provide their financial information and operational results online. In contrast, information about penny stock companies can be extremely difficult to find, making it less likely that quoted prices in the market will be based on full and complete information about the company. Penny stock companies may also be more likely to be the subject of an investment fraud scheme, which may also increase risk for the investor.
No Minimum Listing Standards. Companies that offer shares of their stock on exchanges can be subject to stringent listing standards that require the company to have a minimum amount of net assets and shareholders. Most penny stock companies do not list their shares on exchanges and are not subject to these minimum standards. Again, this fact can contribute to the inherent risk associated with an investment in the shares of a penny stock company.
Risk of Lower Liquidity. Liquidity refers to the ability of market participants to buy and sell securities. Generally, the more demand there is for a particular security, the greater the liquidity for that security. Greater liquidity makes it easier for investors to buy or sell securities, so investors are more likely to receive a competitive price for securities purchased or sold if the security is more liquid. Penny stocks are often traded infrequently and have lower liquidity. You may therefore have difficulty selling penny stocks once you own them. Moreover, because it may be difficult to find quotations for certain penny stocks, they may be difficult, or even impossible, to accurately price.
Risk of Higher Volatility. Volatility refers to changes in price that securities undergo when they are being traded. Generally, the higher the volatility of a security, the greater its price swings. Due to their lower liquidity, penny stocks are subject to greater volatility and price swings. A customer order to purchase or sell a penny stock may not execute or may execute at a substantially different price than the prices quoted in the market at the time the order was placed. In addition, the market price of any penny stock shares you obtain can vary significantly over time. Penny stocks are prone to market manipulation since a small amount of capital and a few trades may suffice to move the price, and a small movement in share price can lead to a significant percentage change.
Penny Stocks Can Be Subject to Scams. Penny stocks are frequent vehicles for scams and/or market manipulation due to their generally lower prices and less stringent listing requirements. You should be wary of advertisements, unsolicited e-mails, newsletters, blogs or other promotional reports that emphasize the potential for large profits in penny stocks generally or certain penny stocks. These promotional materials are often used to manipulate or "pump up" the price of penny stocks before the promoter engages in the selling a large volume of shares. Customers are therefore strongly encouraged to do their own due diligence with respect to any penny stock company they invest in and to not rely on any outside promotional reports or newsletters.