What Exactly Are Penny Stocks?
Beginners just starting out may find the concept of penny stocks a little difficult. There are is no specific answer of what exactly a penny stock is and the meaning of the phrase differs according to individuals and organizations.
What do the big wigs define it as?
It is defined by the Securities and Exchange Commission (SEC) as the trading of stocks that are speculative, high-risk and valued for less than $5 per share.
Some refute this claim by setting a lower cut-off level for their penny stock to $3 or less than $1. Therefore, before investing in them we should determine what characteristic qualifies a stock to be labelled a penny stock.
Market capitalization is also referred to as market cap. It is the total trading value of a company and is a useful factor to consider when determining the size of a company. Penny stocks are mostly associated with newer or smaller companies.
A company below $50 million in market cap is argued by some to qualify for a penny stock. However, the market cap may make the stocks trade above the $5 per share “cut off”.
In another case the stock may trade below $5 per share with a market cap of greater than $50 million.
There is also another scenario where the stock has a market cap above $50 million and trades for less than $1 per share. All three are considered penny stocks but for a wise investor, consider only trading those with huge growth potential.
Price per Share
Penny stocks are associated with small-cap or micro-cap companies that trade below $5 per share. Others will consider them as stocks that trade for less than $1
Exchange for Trading Penny Stocks
There are diverse exchanges for trading stocks including NYSE, NASDAQ, AMEX, OTC (Over-the-Counter) and Pink Sheets. Penny stocks are considered by investors to be shares that are traded only through OTC or the Pink Sheet exchange.
Although most stocks on these two exchanges trade of value less than $1, there can be shares valued for more than $5 trading on OTC or Pink Sheets
Risk of Investment
Penny stocks are perceived as high risk investment vehicles. This is attributed to a lack of market stability of the companies that issue them. Newer and smaller companies in the stock market have a difficult time making accurate financial records available to the public due to their limited liquidity and high fraud risk. This leads to prospective investors having inadequate financial information, making it risky to invest in their stocks.
Reward for Investment
Penny stocks may be considered high risk, but can also be extremely rewarding when properly picked by an informed investor. It is thrilling for a trader to purchase a large cap stock with the prospects of earbing a 10% return. However, for those with an insatiable appetite for risk, it is within the norm to reap 100% up to 1000% in returns with penny stocks. Penny stocks can increase rapidly in value within a short amount of time and investors with a good entry and exit plan can reap huge benefits.