Are penny stocks good to invest in or diversify my investments?  Which brokerage company is good to trade/buy penny stocks? -Tammy

In the volatile investing world of penny stocks, if you don’t pay attention you could end up penniless.

Penny stocks are usually high-risk investments with low trading volumes and the companies are usually startups and small companies with smaller balance sheets and limited resources.

“Penny stocks can be great investments, but can be extraordinarily risky and are generally best for seasoned investors who understand the market and do their homework on the companies they’re investing in,” says Chelsey Loshak, the marketing director at Pink OTC Markets Inc.

What quantifies as a “penny stock” varies, but the Securities and Exchange Commission considers any stock under $5 a penny stock, while other set the bar at $3 or even $1.  

Penny stocks tend to trade on dealer networks like the Over the Counter Bulletin Board [OTCBB], which is owned by FINRA, and the Pink Sheets, an electronic interdealer quotation system that provides real-time bid and ask prices for OTC traded stocks. The big difference between the OTCBB and Pink Sheets is that brokers must call a firm on the phone if they see an appealing price on the OTCBB. Pink Sheets, on the other hand, has an electronic trading platform, so deals can be negotiated electronically.

Buyer Beware

The system has very low reporting requirements and does not have to report to the SEC.

“Learn why a stock is labeled a penny stock before you buy it,” says Reyna Gobel, author of Graduation Debt: How to Manage Student Loans and Live Your Life and contributing author to Investopedia.com. “To one person it could mean a low-priced stock that no longer or never has qualified to be traded in traditional markets. To another person, it could mean a stock that is low-priced, maybe even undervalued.”

If you are just starting to dip your toes into the investing waters, penny stocks could be a safe place to learn the ropes.

“When you’re younger and you’re a little more interested in growing the money you get, and if you get involved in good quality penny stocks, it can be a great thing to invest in,” says Peter Leeds, CEO of pennystocks.com.

Experts agreed that if you choose to enter the penny stock world, just make it a portion of your portfolio.

“Penny stocks are good for a portion of your portfolio,” says Leeds. “Generally that portion is going to be a little more risky, but has a little more potential for growth.”

And if you happened to find a gem in the midst of copper—your rate of return cold be substantial.  

 “IBM [may] make 10% on your money in the next year; if you get involved in a penny stock that does well, it [may] make you 100 or 200%,” says Leeds. “It’ll be a lot quicker too.”

Choosing a Brokerage Firm 

When choosing a brokerage firm, be sure to do your research to make sure it’s legit.

“Look for a company that’s fundamentally sound, meaning that they have a working business model, low debt load, proven revenues, a good management team,” says Leeds.

The penny stock world is littered with scams, warn the experts, so if it sounds too good to be true, it might

“It’s important to do one’s homework, and this is not possible if a company isn’t providing adequate information about their financials to the marketplace, such as the companies in the Pink Sheets No Information,” explains Loshak.

“Worse, beware of companies that are spamming the market trying to inflate their stock price, which can be an indicator of a pump and dump scheme.”

And don’t let the name fool you—the cost of investing in penny stocks could cost you a lot more if a firm tacks on fees for inactivity, balance and cancellations. Always ask about a broker’s fees to avoid surprise charges down the road.