Definition
A penny stock refers to a small company’s stock that typically trades for less than $5 per share. These stocks are considered high-risk investments due to their low cost, lack of liquidity, large bid-ask spreads, and the potential for manipulation. They are usually traded over-the-counter (OTC) or on minor exchanges, rather than on major exchanges.
Key Takeaways
- Penny stocks are low-cost stocks that usually trade for less than $5 per share. They are typically issued by small, less-established companies.
- They are considered highly speculative and riskier than mainstream stocks. This is due to their lack of liquidity, large bid-ask spreads, limited disclosure of information, and the possibility of manipulation.
- Despite the risk, the potential for high returns attracts many investors. However, success with penny stocks requires thorough research, patience, and a considerable tolerance for risk.
Importance
Penny stocks are important in finance because they allow investors, especially those with limited funds, to buy shares in a company at a much lower price.
Even though they’re typically seen as high-risk investments due to their volatility and the fact that they are often associated with small and unestablished companies, they offer the potential for significant returns.
This makes them particularly attractive to speculative investors looking for high-risk, high-reward investments.
Furthermore, trading penny stocks can provide valuable learning experiences in understanding the dynamics of the stock market, making them an important aspect in the world of finance.
Explanation
Penny Stocks are typically low-priced, small-cap stocks offered by companies that are relatively new or lack a robust operational history. Unlike blue-chip stocks, penny stocks are not usually trading on the major market exchanges. The purpose of these stocks is to provide an opportunity for substantial growth through high-risk investments.
They offer an affordable entry-point for new investors or those with minimal investment capital. Companies issue penny stocks to raise funds to grow their business, explore new ventures, or cover operational expenses. Investors trade in penny stocks with the anticipation of profiting from price appreciation.
These stocks are often used for speculative investments where investors hope that the small company will grow significantly, in turn rapidly driving up the price of its stock. While the potential for exponential returns exists, the overall risk is high due to their inherent volatility, lack of liquidity, and the potential for manipulation due to limited regulatory oversight. Due to their speculative nature, they are considered suitable for risk-tolerant and well-informed investors who are not averse to taking on significant risk for high potential returns.
Examples of Penny Stock
Sundial Growers Inc. (SNDL): This Canadian company specializing in cannabis is an example of a penny stock. In 2021, it had a major boost from Reddit’s Wallstreetbets forum with its stock trading under $
While it saw considerable volatility, this example highlights the high risk and potential high reward nature of penny stocks.
Nokia Corporation (NOK): Nokia was once the leader in mobile communications. With the growth of companies like Apple and Samsung, Nokia’s shares decreased significantly. For a while, it’s stock traded below $5 a share, characterizing it as a penny stock. Recently, it also drew attention due to its popularity on the Wallstreetbets forum.
Plug Power Inc. (PLUG): This US company, which develops hydrogen fuel cell systems replacing conventional batteries in equipment and vehicles powered by electricity, had been trading under $5 for most of its public lifecycle. Even though their product is innovative, the slow sales and lack of profitability turned it into a penny stock. However, with the recent shift towards clean energy, their stock has seen an immense increase.
FAQs on Penny Stock
What is a Penny Stock?
A penny stock typically refers to the stock of a small company that trades for less than $5 per share. Although some penny stocks trade on large exchanges such as the NYSE, most trade via over the counter (OTC) transactions.
Are Penny Stocks Risky?
Yes, penny stocks are considered significantly riskier than normal stocks. This is due to their potential for extreme volatility and manipulation, lack of liquidity, and the fact that they’re often not held to the same stringent reporting standards as larger companies.
Can I Make Money With Penny Stocks?
While there is potential to make money with penny stocks, it is important to note that the risks are high. Investors can lose a lot, if not all, of their investment very quickly. It’s essential to do thorough research and consider getting advice from a financial advisor or broker.
What Should I Consider When Investing in Penny Stocks?
Before investing in penny stocks, consider the company’s earnings and growth potential, the liquidity of the stock, the company’s fundamentals, and your own risk tolerance. Also, it’s best to only invest money that you can afford to lose.
Are Penny Stocks Regulated?
Yes, penny stocks are regulated by the Securities and Exchange Commission (SEC). However, they do not have as stringent reporting requirements as larger companies. Consequently, they may lack the detailed financial information that assists investors in making informed decisions.
Related Entrepreneurship Terms
- Over-the-Counter (OTC)
- Pink Sheets
- Low Market Capitalization
- Microcap Stock
- High Volatility
Sources for More Information
- Investopedia: A reliable source of information for various kinds of financial terms, including Penny Stock.
- The Motley Fool: A finance and investing advice company offering a depth of information about Penny Stock.
- U.S. Securities and Exchange Commission (SEC): The regulatory body for the securities industry, which can provide legal aspects of Penny Stock.
- Market Watch: A website that provides financial information, business news, analysis, and stock market data, including information about Penny Stock.
