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The Risks of Penny Stocks

Have you ever been tempted by the line 'if this few-hundred-won stock just goes up 10x, jackpot!'? Let's coolly examine why most investors lose money behind that temptation.

What is a penny stock

A penny stock literally refers to a stock with a very low share price. The U.S. Securities and Exchange Commission (SEC) defines a penny stock as 'a small-company security under $5 per share, usually not listed on a national exchange.'

In Korea, stocks priced under KRW 1,000 are commonly called 'coin stocks' (동전주).

A low share price is not itself a bad thing. The problem is that such stocks are generally small, information-poor, and often traded in markets where trading is thin (in the U.S., the over-the-counter OTC market). By that much, the protection of disclosure and regulation is weak.

Risk 1: liquidity and volatility

The first risk you meet is low liquidity. When there are few buyers, you may not be able to sell at a fair price when you want to, or you may not be able to trade at all. Buying interest can vanish overnight.

The second is high volatility. Because trading volume is small, even a small amount of money can swing the price greatly. It could be +50% in a day, or -50%.

According to SEC research, penny stocks have low liquidity, tend to lose value, experience frequent sharp swings and market manipulation, and most investors ended up with losses (negative returns).

'It can go up 10x' is two sides of the same coin as 'it can drop more than 90%.' High volatility means large moves both up and down.

Risk 2: pump-and-dump fraud

The most notorious risk in penny stocks is price-manipulation fraud called 'pump-and-dump.'

Here's how it works. Fraudsters buy up cheap stock in advance, then spread false good news like 'a jackpot is coming' or 'it's insider info' through social media, group chats, and text messages (pump). When individuals lured by this pile in and the price jumps, the fraudsters sell everything at high prices (dump).

At that moment the price plunges, and those who bought in late are left holding stock that has become worthless paper. The U.S. FINRA warns of such low-price-stock manipulation as a representative investment scam.

'If someone strongly recommends a particular stock to you and tells you to hurry,' that itself can be a warning sign.

Wrap-up: cheap can mean worthless

Penny stocks look attractive because 'they're cheap so you can buy a lot, and even a small rise seems to multiply your money.' But behind that lie low liquidity, extreme volatility, manipulation risk, and the possibility of losing your entire principal.

What this service emphasizes is 'buying good assets for a long time, steadily.' Even verified assets require you to endure drawdowns of -30% or -50%, and penny stocks—which are information-poor and highly prone to manipulation—carry that risk to a far greater degree.

If you aim for a 'big hit' and lose your entire principal, the very chance to recover through compounding disappears. -100% cannot be undone by any rate of return.

よくある質問

Q. Aren't there people who actually made big money on penny stocks?

Some success stories do exist. But that is 'survivorship bias.' Behind the few conspicuous success stories are countless losses that quietly vanished. Even in SEC research, most penny-stock investors ended up with negative returns. You shouldn't underestimate the risk based on a handful of jackpot cases.

Q. If a share price is low, is it automatically a penny stock and risky?

A low share price alone doesn't make it risky. The real risk factors are 'small size, poor information and disclosure, low trading volume, and the possibility of manipulation.' Even for a low-priced stock, it's important to check its finances, trading volume, and disclosure status, and the harder these are to verify, the more caution you need.