The Definition of Penny Stocks

Low-priced stocks of small companies that usually carry a value of less than $5 are called penny stocks. These type of stocks are traded on the Over-the-Counter-Bulletin-Board (OTCBB) and the Pink Sheets. Both of the mentioned trading venues do not have the same kind of minimum requirements of exchanges as those which are set by the Securities and Exchange Commission for the NASDAQ or the NYSE. Penny stocks are issued by those companies that are either starting businesses or approaching bankruptcy. A new issue of stocks is one way of injecting quick capital that can be used to save the business.

Lack of standards, lack of stability, and decrease of prices are some of the factors that cause penny stocks to be one of the riskiest investments around. Although successful companies experience a great payoff, a vast majority of penny stocks often end in bankruptcy. Here are some of the reasons why penny stocks are considered to be risky:

Lack of information about the company
Most companies have very little reportable history and those which are listed in the Pink Sheets or in the OTCBB aren’t required to issue financial statements.

Low liquidity
Finding potential buyers is difficult because penny stocks are infrequently traded. In order to interest an investor to buy the stock, the price of the penny stocks need to be lowered substantially.

Potential fraud.
Penny stocks, as a result of their unregulated nature, are often sold by con artists through spam emails or off-shore brokers.

Not all penny stocks are issued to gain money by fraud or to deal with bankruptcy. There are some penny stocks which are used to represent hard-working businesses that are struggling to meet the necessary requirements to get listed on NYSE of NASDAQ. Investing in such companies offers real growth potential because investors have the opportunity to get in at the ground floor and ride all the way to the top.

Finding companies with this growth potential is difficult. A lot of research is needed to get this information. Unless they willingly take the time to personally investigate a company, investors could be victimized by fraud. Nowadays, there are some companies that offer “inside information” about which companies sell penny stocks. Investors always have to be extra careful since there are other companies which only serve as fronts for pushing particular stocks on unsuspecting investors.

The two ways to play the penny stocks are to do research and to play craps. Since the stocks come with low costs, investors will not lose vast amounts of money in case the company goes under. Penny stocks are also considered to be interesting additions to any portfolio. It must be stressed, however, that only a small portion of any portfolio should consist of penny stocks because the odds are that most penny stocks will end up in a total loss.

Investors who are interested in buying penny stocks need to find a broker that will place orders for them. Although a lot of brokers will not cover penny stocks due to the difficulty in tracking them, there are some online brokers who specialize in penny stocks. Regulations require brokers to receive a written confirmation from their clients concerning the transactions. Brokers are also required to provide their clients with a document that outlines the risks of speculating with penny stocks.

The current market price of the stock and the compensation amount of the firm has to be disclosed by the broker. They also have to provide their clients with monthly statements that detail the market value of each penny stock in the account.

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