What are Penny Stocks?

Penny stocks offer the promise of sensational

returns, but they are not without risk. Heres a look

at what are penny stocks and whether theyre worth

the hype.

With penny stocks, the name is very deceiving. Penny stocks dont actually cost a penny. Instead, they

can be anywhere from a penny to $5, based on the Securities & Exchange Commission definition. Other

heuristics may consider penny stocks to be anything below $10 or $3 or $1. Whatever the price cutoff,

penny stocks are really cheap stocks that typically arent traded on major stock exchanges.

Benefits of Buying Penny Stocks

The benefit of investing in a penny stock is that your investment can easily triple or double. Consider if

you purchase $1,000 worth of a stock priced at 10 cents and the price increases to 20 cents. Your

investment would double and you wouldnt have to wait long to see it happen. However, theres also a

great risk that you could lose half your investment if that same stock price dropped to 5 cents. You could

lose everything if the stock bottomed out or if the company went out of business. There are many

success stories, which is why some investors keep putting their money in penny stocks.

Before you purchase a penny stock, your stockbroker is required to give you a document explaining the

risk of penny stock investment. Sales fees should also be disclosed. The broker or investment firm is

also required to send a monthly statement that shows the current value of your penny stocks. The monthly

statement is especially useful because penny stock companies dont typically file quarterly or annual

financial statements as publicly-traded companies do.

Why Penny Stocks Can Be So Risky

Penny stock companies often are not required to file with the SEC, so theyre not as regulated. Not only

that, it might be hard to find enough information on the company to decide whether its a worthwhile

investment. Youll find few penny stocks on the major stock exchanges, like the Dow or NASDAQ,

because they dont typically meet the minimum standards. Companies may be new, which also means

theres limited information on company performance.

It can be harder to trade penny stocks because its harder

to judge whether the stocks are worth investing in. So,

you may have to offer stocks at a discount to make them

more attractive. There is also the potential for liquidity risk

if the underlying security is thinly traded.

Investors have to watch out for pump and dump scams,

where the scammer hypes up the stock to encourage

investors to buy it. The surge in purchases causes the

stock price to inflate artificially. Thats when scammers

dump their shares and the price subsequently drops,

possibly lower than the investors original purchase price.

Shell corporations are often the prop behind pump and

dump scams. So if youre looking to buy penny stocks, make sure you investigate the company and look

for real business operations.

You should also evaluate the companys financial statements to determine how healthy the companys

finances look. Check that a reputable firm has audited them and that theyve filed on time.

Where to Find Penny Stocks

You probably dont want to invest in a penny stock that you heard about through email, an internet or

television ad, or one that you saw on a penny stock trading message board. Many penny stock scams

are advertised this way.

You can find many penny stocks listed in the over-the-counter (OTC) market, e.g. Pink Sheets or the

Over-the-Counter Bulletin Board. The OTCBB some listing requirements, e.g. that the company be

registered with some regulatory body, that requirement isnt as strict as those from the SEC. However,

Pink Sheets doesnt have any listing requirements. The risk in trading a penny stock is that price

information isnt typically available, so you have to rely on your stockbroker to give you honest price