Fundamentals Of Penny Stocks

In the American financial market Penny Stocks are those stocks that are being traded outside the major exchanges including the NYSE, NASDAQ or AMEX. Often these stocks are disapproved and considered pejorative. The definition of a penny stock in official jargon is - "a stock that is a low priced speculative security of a very small company" - regardless of whether market capitalization is there or not and if it is trading on a securitized exchange like NYSE or NASDAQ or in OTC like OTCBB/ Pink Sheets.

Penny stocks are also known by other names like micro-cap stock/ small caps/ nano caps and so on. These names are used inter changeably. It is to be understood that according to SEC definition the status of penny stocks is decided based on share price and not by marketing capitalization or the stocks' listing service. A penny stock is normally listed for prices below 5 dollars for one share. Traditionally shares that trade at 41 or less per share are referred to as penny stocks but as per SEC definition it is $5.

In the United Kingdom market penny stocks are called as penny shares. They refer to stocks and shares in small cap companies - which are defined as companies with market capitalization less than 100 million pounds and/ or price of a share at less than one pound and having a bid/ offer spread of more than 10%. FSA - Financial Services Authority in the UK - issues risk warning as part of standard regulation on penny shares.
There are many investors who are new in the market or novices are attracted by the penny stocks because they are low priced and they are seen to have potential for fast future growth. This perception happens when the stocks are being promoted avidly. But if investors are not careful they can have severe losses because it is a fact that many penny shares have lost all their value in the long term. The penny shares have less liquidity, there is no formal financial reporting and the business is fraught with fraud. Because they lack liquidity these stocks are easy to manipulate. Similarly sudden demand or supply changes in penny shares can cause volatility in stock prices. Requirements to get quoted at OTCBB are bare minimum only. That is why SEC warns that such stocks are in the high risk investment category and ensures that new investors are aware of all the risks involved.
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