What Are Penny Stocks
What Are Penny Stocks?
A penny stock is the stock of a small company that trades for less than $5 per share. Penny stocks can be traded on large exchanges like the New York Stock Exchange (NYSE) or through over-the-counter (OTC) transactions on the OTC Bulletin Board (OTCBB) or OTC Markets Group.
Key Takeaways:
– Penny stocks are stocks of small companies that trade for less than $5 per share.
– Most penny stocks trade on the OTCBB, although some trade on large exchanges like the NYSE.
– Trading penny stocks can result in sizable gains, but there is also a high risk of losing a significant amount of investment.
Understanding Penny Stocks
In the past, penny stocks were defined as stocks trading for less than one dollar per share. The definition has since been modified to include stocks trading below $5 per share. Penny stocks are associated with small companies that lack liquidity, making it difficult for investors to sell their stock at a fair market price.
Due to their lack of liquidity, wide bid-ask spreads, and small company size, penny stocks are considered highly speculative. Investors should be aware of the high risk of losing their investment.
Penny Stock Volatility
Penny stocks are often associated with growing companies with limited resources. They are suitable for investors with a high tolerance for risk. Penny stocks have a higher level of volatility, which means there is a higher potential for both rewards and losses. Investors should set up stop-loss orders to limit losses and have realistic expectations of penny stocks.
Advantages and Disadvantages of Penny Stocks
Penny stocks have advantages such as providing funding opportunities for small companies and the potential for significant upside in share appreciation. However, they also have disadvantages such as low liquidity, limited information available, and a high probability of fraud and bankruptcy.
Tips for Investing in Penny Stocks
Investors in penny stocks should conduct proper due diligence before investing and rely on reputable stockbrokers. It is important to never invest more than you can afford to lose and be aware that steady returns are more common with established large-cap equities.
Can You Make Money on Penny Stocks?
Despite the risks, penny stocks can be profitable for cautious investors. However, it is important to avoid fallacies such as believing in the opportunity for large gains and considering low-priced securities as inherently "cheaper."
Signs of Scams
While there is no fool-proof strategy for identifying fraudulent penny stocks, investors should be wary of companies with SEC trading suspensions, large assets but small revenues, unusual items in financial statements, auditing issues, and large insider ownership.
Real-World Example of Penny Stock Scams
There have been instances of penny stock scams, such as a case where companies sold penny stocks in a fraudulent manner. Perpetrators of such scams were found guilty of securities fraud.
How Is a Penny Stock Created?
Small companies and startups issue stock to raise capital. A penny stock is created through an initial public offering (IPO) process. The company must file a registration statement with the SEC for the stock to be listed on the OTCBB or engage in over-the-counter trading.
Regulations for Penny Stocks
Penny stocks are considered highly speculative investments, and the SEC and FINRA have rules to regulate their trading. Broker-dealers must comply with specific rules, including approving transactions, providing standardized disclosure documents, disclosing prices, and providing monthly account statements.
After-Hours Trading
Penny stocks can be traded after hours, leading to volatile fluctuations. However, penny stocks have low liquidity and inferior reporting, making it difficult to buy and sell after hours.
When Is It Not a Penny Stock?
Events such as registering securities with the SEC or fulfilling reporting requirements can cause a penny stock to transition to a regular stock.
Example of a Penny Stock
Most penny stocks do not trade on major exchanges. However, some large companies with market capitalization below $5 per share are considered penny stocks.
Where Do You Buy Penny Stocks?
Penny stocks can be traded on the OTCBB or the OTC Markets Group. They are also available through brokerage accounts like Fidelity or Charles Schwab.
The Bottom Line
Penny stocks refer to shares of small companies with low prices and low trading volumes. Investing in penny stocks carries high volatility and risk, with potential for both large profits and losses.
