What Are Penny Stocks

What are Penny Stocks
Many of us have heard of penny stocks and some of us have probably heard of someone that has invested in a penny stock and doubled their money.

But, what are Penny Stocks and what makes a certain stock a penny stock?

Well, there is really no absolute definition of what a penny stock is and definition varies by some individuals or organizations.

The Securities and Exchange Commission (SEC) defines the term “penny stock” to be stocks trading for less than $5 per share and considered them high risk and speculative. Some set the cut-off point at $3, while others consider only stocks that trade under $1 to be penny stocks. It all depends who you are dealing with!

So, lets take a look at the different criteria of what some may define as a penny stock.

Penny Stocks can be defined by:

Price Per Share:
Stocks trading under under a certain price are considered to be penny stocks. As stated above, the Securities and Exchange Commission (SEC) defines the term “penny stock” to be all stocks trading for less than $5 per share and some people consider stocks that trade under $1 to be penny stocks.

There is a variety of stocks that trade between .01 to $5 per share and trade on the NASDAQ, NYSE, AMEX, OTC (Over-the-Counter), and Pink Sheets.

Exchange Stocks Trade Upon:
Stocks trade on a variety of exchanges, such as NASDAQ, NYSE, AMEX. There are also stocks that don’t trade on any exchange but rather trade over-the-counter. These stocks are quoted through the OTCBB (Over-the-Counter Bulletin Board) and Pink Sheets (now the OTC Markets).

The NASDAQ and NYSE are the two largest exchanges and features stocks with a market cap that range from small to large. Stocks that trade on these two exchanges are required to meet a certain standard and disclose their financial details about their company.

While, stocks that trade over-the-counter on the OTCBB or Pink Sheets have very little or no requirements to be listed and feature stocks with small, micro or nano-cap stocks. It also features stocks that may have once been listed on the NASDAQ or NYSE and didn’t comply with the exchanges listing requirements or maybe be stocks on the brink of bankruptcy.

Some will consider stocks that trade only on the OTC (Over-the-Counter) or the Pink Sheets to be penny stocks. Although, most stocks might trade for under $1 per share on the OTC or the Pink Sheets, there is also some that trade higher than that and some may even be trading at levels of $10 per share or more.

Market Cap:
Some consider any company beneath a certain market cap, such as a market cap under $50 million as a penny stock. But, a stock that has a market cap under $50 million may not be trading under $5 per share, some maybe trading much higher than that.

Sure, there are plenty of stocks that trade under $5 per share with a market cap under $50 million.

But, there might also be a stock that trades over $5 per share with a market cap under $50 million that maybe poised for massive growth. There might also be a stock with a market cap of $2 billion that trades for $.90 per share, but could you consider this a penny stock if it seems like it doesn’t have much more room to grow?

As you can see it is a bit difficult of putting an absolute definition of what are penny stocks. But, what it comes down to is that there are “different types of penny stocks.”

For me I consider penny stocks to be stocks trading under $5 per share and must be under a certain market cap. But, that doesn’t mean I just look for opportunities for stocks trading under $5 per share, I also look for stocks that may trade above that and are ready for massive growth.

I typically look for penny stocks of the highest quality that are small or micro cap companies. These penny stocks trade between .01 to $5 per share and trade on the NASDAQ, NYSE, AMEX, OTCBB (Over the Counter Bulletin Board), and Pink Sheets.

What else should you know About Penny Stocks?
Penny stocks are often considered high risk and speculative stocks. Penny stocks are often the target of pump and dump scams. You can read more on that in one of my post about Penny stock scams.

Some Penny stocks that trade on the OTC or Pink Sheets are thinly traded with very little volume and it can be difficult to buy or sell shares. Penny stocks tend to move faster and are more volatile than larger cap stocks, have huge swings of up and down.

What attracts people to penny stocks is the notion that a small investment of just $500 can multiply many times over, compared to a slow-moving blue chip stock. Penny stocks offer you the chance to double, triple, quadruple your money.

If a stock is at 10 cents and rises by ten cents, you will have made a 100% return. Many investors think that micro cap stocks are a rapid way to double your money.

Sure, this is true in some cases, but people tend to see only the upside of penny stocks, while forgetting about the downside. A 10 cent stock can just as easily go down by 5 cents and lose half its value or more and may never get back to that level again.

The point is, whenever investing in Penny stocks, make sure you do extensive research and understand what you are getting into. And if you are trading penny stocks you should always put in a tight stop loss.