According to the SEC, penny stocks are considered to be any stock trading below $5 per share whether they are listed on an exchange or trading through the Over The Counter Bulletin Board (OTCBB) or pink sheet markets.
Penny stocks, often referred to as microcap or even nanocap stocks, are usually smaller or newer companies with limited resources that are looking for the same thing larger companies are, access to capital through the open markets.
Companies trading on the OTC (over the counter) and through the pink sheet markets have fewer regulations placed on them as compared with stocks listed on the NASDAQ and NYSE. As a result, stocks on the OTC market are highly susceptible to manipulation and fraud.
The only penny stocks I trade are listed on the NYSE or NASDAQ. I know these companies are facing stricter requirements to maintain compliance and therefore are less likely to be fraudulent companies. Trading the OTC and pink sheets is like living in wild, wild west and can be very unforgiving.
Penny stocks have earned the reputation of being highly risky assets due to their lack of business history, liquidity and volatility and are more suitable for traders with a higher tolerance for risk.
Penny stocks are often victims of pump-and-dump schemes where people will promote a stock that they have loaded up on through email or trading forums and then sell as news gets out and new buyers are picking up shares. This happens all the time and something new traders need to be cautious of. Buying the hype can leave you holding the bag!
What’s So Attractive About Penny Stocks?
Trading penny stocks has become very popular over the years as new traders with less capital can put on larger positions. At such a cheap price, traders can buy thousands of shares with a small amount of starting capital and even though it can be very risky, there are a lot of traders who make a living from just trading penny stocks.
This can be very risky and is best to start off small while you develop a trading strategy that can consistently make you money.
Another reason penny stocks are so attractive is because they have the potential to bring in huge returns with runners of 100% to 200% happening all the time. Most new traders come in with the preconceived notion that they will become millionaires overnight by trading penny stocks but that is not the case at all.
It takes a lot time, experience and losing trades to learn the ropes.
LiveTraders Pro Tip
Most professional penny stock traders stick to trading stocks that are listed on an exchange because of the risks mentioned above. When you are first starting out as a new trader, it is important to understand that trading is hard. Very hard.
And putting on too much risk can have a devastating impact on your trading account, so make sure to trade smart and limit your exposure in the volatile land of penny stocks.