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What are penny stocks?

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Quick Answer

Penny stocks are securities generally issued by small, publicly traded companies and usually trade at a price of less than $5, according to the U.S. Securities and Exchange Commission. The low price and high volatility of penny stocks makes them highly speculative investments that carry significant risk but also the potential for significant profits.

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Full Answer

According to Jonas Elmerraji for The Street, penny stocks are often listed on special reporting services such as Over-the-Counter Bulletin Board, or OTCBB, and Pink Sheets. Penny stocks can usually be purchased through a traditional stockbroker, though the SEC requires that any broker dealing in penny stocks send a written notice to the client that warns of the elevated risk associated with such volatile instruments.

Of special concern is the unique difficulty analysts face in trying to price penny stocks. Since many companies that trade in penny stocks have low investment caps and limited shares available for public trading, it can be difficult to develop an accurate picture of a stock's true market value until after the investor buys into it, notes Elmerraji. The inherent danger in such a system is that investors can easily buy large amounts of overvalued stock and suffer serious losses, which is why penny stocks receive close regulation.

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