To put it simply, penny stocks are any security available for purchase; however they are not traded on the formal stock exchanges: the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) or the National Association of Securities Dealers Automated Quotation System (NASDAQ). To buy penny stocks, one must go to a dealer network, thus giving these stocks the name over the counter or OTC stocks.
Penny stocks are traded over the counter and not on formal stock exchanges primarily due to the fact that the company does not meet revenue or asset requirements. This does not necessarily indicate that the company performs poorly, but rather that the company is small or may just be starting up. Penny stocks are referred to not only as over the counter stocks, but also unlisted stocks because they are not listed on any stock exchanges, and must be traded by specific dealers.
Penny stocks get their name from their low price, usually under 5 dollars per share. This does not mean that stocks listed on the stock exchange are referred to as penny stocks if there price falls below 5 dollars, though it is easy to confuse unlisted penny stocks with listed stocks below 5 dollars per share. To determine whether or not a stock is a penny stock company or a listed company, simply look at the company’s stock symbol (code). The symbol is followed by OTC or OTCBB, the share is an actual penny stock. A listed company, regardless of stock price, will never be a penny stock as it will fulfill the requirements to be listed on the stock exchange. Conversely, penny stocks will never be listed stocks, even if the share price rises to over 5 dollars. Penny stocks must be traded on the over the counter bulletin board or listed in the Pink Sheets as they do not appear listed on any major stock exchange.
Over the counter bulletin board stocks, or OTCBB, are not the same as regular OTC stocks. OTCBB stocks belong to companies that have a history of bad credit. It is not to surprising that OTCBB stocks oppose a much higher risk to investors as compared to OTC stocks.
With that being said, why would a company issue a penny stock, when it can stay a private company? For the most part, penny stocks are issued by new, up and coming companies who need to raise investment capital. However, penny stocks may also be issued by companies who can’t meet the asset and profit requirements of the stock exchange, or even companies that have been dropped from the stock exchange. When trading penny stocks, it is absolutely important that you know why a company has issued the penny stock in order to determine whether or not it will be a good investment. Penny stocks have the potential of huge profits, however, the risk is equally as high. Purchasing a penny stock of an innovative and new company at 15 cents could see the stock price hit 15 dollars overnight, yielding 100 times your initial investment. But if you make the wrong choice, you may end up losing your entire investment.
The most important thing when trading penny stocks is knowledge; understanding why a company is issuing penny stocks is critical in making a good investment decision. Though the potential for profit is high, so is the risk, making penny stocks exciting and even dangerous to trade.