A penny stock is oftentimes quite literally a stock worth several pennies. However, as these companies grow and/or stocks become more valuable, it's possible to still be considered a penny stock, even if the price is above 10 USD.
Companies that are considered to be penny stock, are usually small, risky companies. The risk lies within the unknown future and often lacks transparency into the companies finances and strategic direction.
When is a stock a penny stock officially?
The SEC (Securities and Exchange Commission) states that a penny stock should be worth less than € 5,- a share. Yet, this is often not what investors mean by a penny stock.
Investors often define the concept as a share is listed for less than € 1. This is mostly used as a benchmark due to the existence of large companies that are stable, but worth less than € 5,- a share.
Finally, some might argue a penny stock is a stock that is listed on an exchange specific to small caps such as Nasdaq small-cap, OTC bulletin board, or OTC markets board (pink sheets). This is where most stocks start if the company is going public prior to achieving a large market share and/or brand recognition.
Why do penny stocks have a bad image?
Penny stocks have a somewhat bad image. This is partly due to the "pump-and-dump scenario". This is a scam where people buy a large batch of penny stocks and then try to promote the stock.
Often this happens with false information and misleading advertisements that promise a lot of return. As soon as the stock rises and people fall for the sweet talk, the shares are sold with a good margin.
This way of trading is not allowed, but it has happened in the past. We, therefore, urge you to always be careful when deciding to effectively gamble on a penny stock.
It could be part of anyone's portfolio, but Investing Guides keeps the total penny stock share to total portfolio around 2% or lower. This way, even if the 2% is fully lost, your overall portfolio will compensate in return.
What are the risks of penny stocks?
Simply put, you could lose all your money due to the company losing face, losing money, or being a scam. On the flip side, is the chance of high returns that are appealing at face value.
Just remember that returns always go hand in hand with risk. With a high return comes high risk. This also applies to penny stocks. In short:
- The liquidity is often poor
- Selling penny stocks is often difficult
- Incomplete or unreliable company information
- Little to no supervision.