Penny Stocks – What Are They?

You may have heard of it before and probably ignored it because you didn't understand it, or the whole term now that you hear it is Greek to you. A stock market placement that earns you a penny? It's very confusing indeed but not that difficult to understand.

You're probably familiar with the NASDAQ, AMEX, and NYSE. Or maybe not. These are the major stock exchanges, where the stocks of big companies are traded. Anything outside of that is called penny stock trading.

A penny stock is a stock that is traded at under $5.00 per share. These are stocks of companies whose capitalization is below $300 million. Penny stocks are also called micro stocks, small caps, or microcap stocks.

Penny stocks are traded over the counter meaning directly between two parties: you and the seller through a market maker. A market maker, also called a broker-dealer, is a company that quotes a buy price and a sell price on a stock. Over the counter trading (OTC) works like this: A company wants to sell its stock, and approaches a market maker. The market maker quotes a buy price to the seller, and decides on sell price.

The sell price is published on an electronic quotation service, usually online, such as the otcbb or Pink Sheets. You see the stock, you like the price, and you buy it from the market maker. As the stock increases in value you make your profit. The market maker made his profit on the spread between the seller's selling price (his buying price) and the price at which he sold the stock to you (his selling price).

The OTCBB, or Over The Counter Market Bulletin Board, is a regulated quotation service displaying real time quotes, last sale prices, and volume information on penny stocks. Companies trading on the OTCBB are required to report their financial information to the SEC, banking, or insurance regulators to meet eligibility requirements.

Companies that don't report their financials are marked on the board with an at the end of its ticker symbol, and given 30 days to report. If at the end of the 30-day grace period the company still has not reported its financial information, it is delisted from the OTCBB and moved to the Pink Sheets.

The pink sheet is an electronic quotation service owned and operated by Pink Sheets lic. Because companies are not required to fulfill any requirements in order to be listed on the Pink Sheets, this is where most small companies who do not wish to disclose their financials choose to trade their penny stocks. The pink sheets are so named because of the color of the paper on which the stock quotes are printed.

Penny stocks can be big earners because there are only a few of you trading the stocks, but they also pose a higher risk than the major stock exchange trading. Because there are very few traders, a buy or a sell can make the value of the stock jump high or low very quickly. Unlike stocks in the major boards where the rise and decline in value is slow, penny stocks can easily jump up by 25% on any given day, and just as easily decline by that same percentage on any day.

Most of the people who trade penny stocks are those trying to find that quick buck or hoping to discover a diamond in the rough. With penny stocks there is no guarantee that the stock you are buying will be a worthwhile investment because this kind of stock is easy to manipulate.

If you're looking for a stock investment but have only a small amount to invest, penny stocks may be for you. But before you invest on any particular penny stock, make sure you do your research on the company's legitimacy, financials, and performance. It may be easier to invest in penny stocks because they're affordable, but you may just as easily lose your investment if you're not careful.