How Do Penny Stocks Work?


Quick Answer

Penny stocks work just like regular stocks, with the main difference being that investors buy and sell penny stocks in over-the-counter bulletin boards (OTCBB) or the pink sheets. The term "penny stocks" refer to stocks that are worth no more than $5 per share, according to the Securities and Exchange Commission, or SEC. While there are large and legitimate businesses that are on the pink sheets, a good portion of the businesses on the pink sheets are less-than liquid and have questionable business practices.

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Full Answer

Some new and inexperienced investors often find penny stocks attractive because of the low cost of share prices and the prospect of making huge profits off of the shares. However, investing in penny stocks is far more riskier than buying from large and well-established companies.

The risk of investing in penny stocks arise from several factors and these include the lack of minimum standard to trade on the exchange, lack of information about the business being traded, lack of company history and the questionable liquidity of the businesses.

The pink sheets are notorious for being a breeding ground for fraudsters who engage in underhanded trading tactics, such as stock price manipulation and the "pump and dump" scheme. The pump and dump is a tactic wherein unscrupulous brokers hype up (or pump) the stock to make it attractive and then sell (dump) it in bulk to unwitting investors.

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