Why Penny Stocks Are High Risk Investments?

In the past few months, a number of financial sector stocks were thrown into penny stocks realm and even bigger banks declared bankruptcy. Taking an unprecedented action of banning short sales SEC called for a short cover on financial sector stocks that have taken a beating by the shorts.

These penny stocks have, often been considered as high risk investments because of the following reasons.

1. Generally, penny stock companies are new start-ups lacking in information and management. And there is no doubt that financial sector companies suffer from the same lack of transparency. The methods are too complicated for any layman to analyze. So, one can rely on the banks when they are in a conflict with each other. But there are less chances for it.

2. Because the interest of the founders of these stocks is aligned with the rest of the share holders, the penny stock company founders cannot sell their shares for a quick profit at the detriment of other shareholders. So, it is obvious that fund managers hold the large volume of these stocks as blocks thereby impairing the return on these stocks to themselves. And moreover, the CEO's of the companies barely have any stock in their portfolios.

3. As we all know, penny stocks are often sold through spam email or off-shore brokers. Because most of the CEO's have offshore accounts, they may be no more honest or dishonest than the operators of stock companies.

By being exemplified by the financial sector both traditional penny stock startups and the fallen, have the potential for growth as well as for fraud.

Cash requirements, short sellers and image problems blight both. The only difference is that the typical startup penny stock company is vilified whereas on the other hand, the fallen companies seek shelter from government and SEC.

The advantages of low price, high inside ownership, the absences of the ability to short and of derivative manipulations come along with these penny stocks. They have more comparative transparency as compared to other stocks. By the choice of a right promoter, one can easily come across the disadvantage of low visibility.

Every one believes in investing in well chosen and well researched stocks which can provide a superior return to ones investments, particularly in mainstream equities. To evaluate a company’s worth in traditional sense also means to give equal importance to the stock promoters.