All penny stocks come with a degree of risk. Yes, even the best penny stock can be a risky investment opportunity for beginner investors, as well as seasoned veterans.
Penny stocks are stocks that are normally traded outside of the sanctions of the world’s major market exchanges, and are traded at relatively small stock prices, and, usually, they come with small market capitalization.
Penny stocks are known for being very speculative, as well as coming with a high degree of risk because of numerous factors that surround them. Some of these factors include a lack of liquidity, larger than normal bid-ask spreads, limited disclosure, as well as a lack of information and stock history.
These stocks are usually traded over the counter through OTC Bulletin Boards, as well as pink sheets.
Where Did Penny Stocks Come From?
The term penny stock has grown and evolved along with the market over time. While there was a time when any stock that traded for less than a dollar per share was considered a penny stock, new Securities and Exchange Commission (SEC) regulations have modified the penny stock definition to include all stock shares that are traded below the $5 range.
While the vast majority of penny stocks (including the best penny stocks) are not usually traded on the major market exchanges, there are a few cases of large companies that have shares trading below $5 while still on the main exchanges thanks to market capitalization.
This means stocks such as Curis Inc. (CRIS) – a small-scale biotech company – can have its penny stock listed on the Nasdaq. However, stocks like CRIS are not typical of a penny stock. Typically, a penny stock is indicative of a smaller company with highly speculative shares. These smaller companies are usually subjected to much more limited requirements when it comes to listing their stock, as well as much fewer filling and regulatory standards.
How are Penny Stocks Created?
Much like any other publicly traded stocks, penny stocks are created via the process of an initial public offering (IPO.) This means that in order for the penny stock to be created a company must first file a statement of registration with the SEC (though there are some situations where a company may qualify to be exempt from SEC registration.) While the company works with the SEC, it must also make sure that it meets the requirements of securities laws in the locations where they plan on selling the stock.
Once they jump through these hoops, the company may begin to solicit orders from prospective investors, and (if these choose to,) the company may apply to have their stock listed on a major exchange, or just have the stock trade on the Over-the-counter market (OTC.)
Small companies, as well as start-ups, usually issue stock as a way to start raising capital to help fund the initial growth of the company. While this process is a long, and costly one, issuing stock can also be one of the most efficient strategies for these companies to build this capital. Penny stocks tend to be the result of these capital-growing ventures, which means they can be very profitable, but also precarious.
When Does a Penny Stock Stop Being a Penny Stock?
There are a few things that can happen that would trigger a penny stock to change into a regular stock. If the company you have penny stock in issues new securities within an offering that is already registered within the SEC, or if it registers a preexisting class of securities with the proper regulatory body. These transactions result in the stock can be triggered into becoming a regular stock.
This change occurs because they then require the firm to obey periodic reporting and disclosure of business activities, financial conditions and company management to investors.