Penny stock
A Penny stock is a loosely defined term that can be used in reference to any stock trading at prices below $5 per share .
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Expanded Definition
The term "penny stock" is most commonly used to refer to stocks of companies with very small market capitalizations that trade on The Over the Counter Bulletin Board or the Pink sheets, although technically it can cover any stock under $5 per share.
The Securities and Exchange Commission has special broker requirements for penny stocks, including the requirement that brokers who wish to offer penny stocks to their clients must give special warning to them of the danger of investing in penny stocks [1].
Penny stocks are not typically covered by Wall Street analysts or mentioned in business media.
Criticism
Penny stocks are often criticized for being risky investments, and for good reason. They typically are thinly regulated, have to meet less rigorous listing requirements, can have questionable business practices, and can be very illiquid.
The speculative nature of their shares coupled with the lack of oversight and media exposure can make penny stock vulnerable to stock manipulation schemes such as pump and dump. [2]
Most penny stocks do not ever shed penny stock status. [3]
Pump and Dump Scams
Penny stocks can be vulnerable to stock manipulation schemes such as pump and dump. This scam works by popularizeing a stock so that demand goes up, the price goes up, and then all efforts at holding the price up are halted and the stock price crashes. The only ones who benefit are the ones who owned the stock before the scam started, as they sold to suckers who bought as the price climbed and now hold shares worth a lot less than what they bought.
There is also the less common short and distort scam. Their small size and lack of exposure to analysts and the business media can make them an easy target for criminals to manipulate these stocks. Penny stocks are frequent targets of such scams.
Scammers typically employ paid mailers, fax blasts and/or spam stock touts in ensnaring their victims. [4]
If you ever receive an email that claims to give you the name of a company or stock that is supposed to double or triple within the next few days, quickly delete it and ignore it, as it is likely a scam, such as a pump and dump.
Common Misconceptions
For some reason, many people believe that owning a lot of shares, in the thousands, is worthwhile or it makes them feel like a bigshot. "I own 100,000 shares!" Big deal. If the share price is two cents, you've got a grand total of $2,000 invested. A single Berkshire Hathaway B-class share holds more value.
Another wrong belief is that it is "easier" for a stock to move its price from $0.50 to $1.00. "It's only a 50-cent move!" they rationalize, looking at all the movements of more respectable companies where 50 cents is nothing. What is overlooked is that this move is a 100% move, and it is the rare company indeed that can double its value (especially for something that is basically worthless to begin with) in a short time (or sometimes even a long time). A 100% move is required, whether the stock price is $0.50 or $35.
Many investors consider penny stocks to only include small market cap companies, however the Securities and Exchange Commission defines Penny Stocks as "The term “penny stock” generally refers to low-priced (below $5), speculative securities of very small companies. While penny stocks generally are quoted over-the-counter, such as on the OTC Bulletin Board or in the Pink Sheets, they may also trade on securities exchanges, including foreign securities exchanges. In addition, penny stocks include the securities of certain private companies with no active trading market." [5]
Some investors mistakenly believe many traditional stocks that are large stocks today by market capitalization to have been penny stocks in the past. This error usually occurs if one forgets to factor in stock splits into a stock's past price. [6]
Day Traders
Despite their inherent risks as long term investments many daytraders like to trade penny stocks, due to their volatility and perceived potential for a quick profit. Notable Penny stock traders include Timothy Sykes and the CAPS player EverydayInvestor .
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