What is a penny stock?

What is a penny stock?

A penny Stock is a term for equity shares valued below $5, many of which are not registered with the SEC and trade over-the-counter. They do trade on over-the-counter exchanges regulated by FINRA.

Penny Stocks are equity in companies that may be small or have bad credit ratings, whose shares are priced below $5, per the SEC definition, but below $1 in the more widely accepted street definition. Because they do not have to observe all of the disclosure requirements of the SEC, there is not very much transparency about the companies or brokers issuing penny stocks.

Penny stock prices may be listed on the Pink Sheets, which is a privately held exchange company which has no listing requirements, and companies issuing shares here do not have to register with the SEC most often.

The Over The Counter Bulletin Board and the OTC Link are exchanges which facilitate the trade of penny stocks and some other over-the-counter instruments, and are regulated by FINRA, the industry Self-Regulatory Organization (SRO) as well as, to some degree, the SEC, which can put a temporary moratorium (stop) on trading if things look suspiciously like a pump-and-dump or another micro-cap fraud tactic.

Companies issuing shares on the OTCBB do have to register with the SEC but they regulations are not as stringent here as on the larger exchanges. There is liquidity risk inherent in these shares since they come with relatively small market capitalization and there just isn't a very large market on which to find a buyer if you wish to sell.

There are also generally large bid-ask spreads. Trading in penny stocks is highly speculative and because of the relative lack of regulation, reporting, and disclosure required, and investors should be advised that these markets are "buyer-beware".

Still, today you can acquire penny stock positions through major retail accounts such as Scottrade and Etrade.