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Penny stocks are booming, but be aware: it likely won’t last

Newbies are flocking to cheap micro-stocks but don’t truly understand the risk.

Penny stocks are on the rise, driven by an influx of new traders and fed by a pattern of increased market volume that marked the latter half of 2020. Right now, these low-dollar stocks are performing well, but analysts warn it’s only a matter of time before the bubble bursts.

Penny stocks are on the rise

On Monday, penny stocks accounted for one-fifth of the overall trading volume, Bloomberg reported. In fact, 6 out of 10 of the most popular stocks for the day were priced below $1 and amounted to some 2.6 billion shares trading hands.

The day stood as a testament to an emerging 2021 trend: that the penny stocks business is booming and investors are profiting from these typically volatile, high-risk stocks. Small-cap stocks priced below $2 per share have swelled nearly 13% in 2021, according to Bloomberg.

What’s also worth noting is the sheer volume of trades. While the 14.8 billion shares moved last week doesn’t quite unseat the record of 17.5 billion shares set the week of March 20, 2020, it’s still up there and confirms that the increased trading volume we saw last year is likely to continue. At least for now.

Why penny stocks?

Financial analysts suggest the recent penny stocks boom is further evidence of the bull market driving the IPO frenzy and Bitcoin’s double-digit gains. The recent surge of interest in microcap stocks is interesting to watch, and so far, has been profitable for the investors involved.

But analysts warn that it won’t last. And recent popularity aside, many consider penny stocks to be a high-risk investment.

Risks of investing in penny stocks

Penny stocks are cheap, move fast and hold the potential for exponential growth — but they’re volatile. Here are some major risks to consider before you get involved with penny stocks:

  • Volatile. Penny stocks typically come from young companies that lack robust financial documentation. These stocks have no track record to speak of and often experience sizable rises and drops in price — often on the same day.
  • No dividends. If you prefer investments that can offer ongoing income, you may want to pass on penny stocks: they rarely pay dividends.
  • Illiquid. Once holding a penny stock, it may be tough to get rid of, as persistently low volume and pump and dump manipulation have plagued this market segment in the past.
  • Limited company data. Penny stocks aren’t subject to the same regulatory standards as larger, better-established stocks. With less financial documentation to rely on, it may be difficult to accurately gauge the risks associated with a particular penny stock.

Penny stocks alternatives

Penny stocks may be low-cost and high-thrill, but this combination can be dangerous — especially for those new to investing. Generally speaking, penny stocks are best handled by experienced investors with high risk tolerance who are comfortable day trading.

If you’re interested in small- or microcap stocks but don’t feel ready to swap individual OTC shares, you may want to consider following an index that backs small-cap stocks, like the Russell 2000. This market-cap weighted index tracks 2,000 of the smallest-cap companies in the US.

While you can’t invest in the Russell 2000 directly, you can purchase ETFs that track the fund, like the iShares Russell 2000 ETF (IWM) or the Vanguard Russell 2000 ETF (VTWO).

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