Penny stocks, commonly referred to as “cent stocks”, are lowly priced shares of publicly traded companies.
These companies are typically very small in size and their diminutive nature is reflected in the stock price. Penny stocks are defined by the Securities and Exchange Commission (SEC) as a publicly traded stock that is bought and sold beneath the $5 mark.
Some are traded at a value as low as half a cent. Penny stocks are not listed on any national trading exchanges. They are typically traded on the OTC (Over The Counter) Bulletin Board and Pink Sheets. The SEC has established a set of rules to govern penny stock transactions.
Penny Stocks: Volatile And Stigmatized
This investing method is typically quite volatile and move up and down in value on a regular basis. This is partially due to the fact that their prices are incredibly low, so an investor can scoop up or sell a large number of shares with a moderately sized investment. These low-cost investments are oftentimes criticized as being tools of manipulation by seasoned stock traders who tout them to the public then sell the stocks after the public has bought in.
This is known as a penny stock “pump and dump”. This low-cost investing method has a much lower trading volume than stocks of significant value. When there is a spike in volume, red flags are often raised as pump and dump stock fraud could be the catalyst for the heavy trading.
SEC Criteria For Penny Stocks
The SEC requires this investment style to meet certain regulations in order to qualify for the classification. These include levels of market capitalization, price, shareholder equity and more. Regular stocks traded on national stock exchanges are not labeled as penny stocks when their values dip below the $5 mark because the SEC fears that they would be much more vulnerable to investor manipulation if taken to the Pink Sheets or OTC Bulletin Board.
What are the Risks?
This type of investing is considered a risky investment as the companies are unproven, trading is volatile, the stocks are often picked by scam artists and they have a lack of history. There’s less information available on penny stocks compared to those listed on national exchanges. Since penny stocks aren’t traded on popular stock exchanges, they don’t file with the SEC.
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This means that they aren’t held to high standards of analysis and scrutiny. Pink sheet penny stocks are not required to file timely data with any overseers. Penny stocks also don’t have to meet minimum standards to continue their eligibility for trading on the OTC Bulletin Board.
It’s also oftentimes difficult to find penny stock buyers. There’s little point to owning a stock if you aren’t free to sell it at any moment that you see fit. This is oftentimes the catalyst for pump and dump fraudsters to beat a penny stock’s drum. They do so looking to generate buying interest in the stock so that they can find a crowd to unload their shares onto at a profitable price.