What is a penny stock?

The term penny stock has evolved with the market. In the past, penny stocks were stocks that traded for less than a dollar per share. The SEC, however, modified the definition to include all shares trading below $5.

If some of these stocks now trade above $1, why are they still called penny stocks? Well, even though some of these stocks may be selling for more than pennies, they are still called penny stocks because they are perceived the same way that stocks trading under a dollar were perceived in the past: as very risky investments. Penny stocks are typically growing companies with limited cash and resources. In other words, most penny stocks are high-risk investments with low trading volumes and limited attention from investors. These companies trade mostly on the OTCBB and Pink Sheets and are susceptible to different forms of market manipulation that are less prevalent and more difficult to employ in stocks found on the Nasdaq and NYSE.

So, be wary of penny stocks. The chances of huge profit are counteracted by even bigger chances of huge loss. Also, don't be fooled by people telling you that companies like Microsoft were once penny stocks. This is a fallacy: Microsoft never was (and very likely never will be) a penny stock.

For a closer look at these higher-risk investments, see The Lowdown on Penny Stocks.

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