Penny Stock
Definition
A stock that trades at a very low price per share (typically under $5), often from small companies with limited operating history, low market capitalization, and high volatility.
Penny stocks are shares in very small companies that trade at low prices, typically under $5 per share. They're often listed on over-the-counter (OTC) markets rather than major exchanges like the NYSE or NASDAQ, though some low-priced stocks on major exchanges also qualify.
These stocks carry extreme risk for several reasons: limited financial disclosure (OTC companies have minimal SEC reporting requirements), low trading volume (making it difficult to sell when you want), wide bid-ask spreads (you can lose 10-20% immediately just on the spread), and high susceptibility to manipulation ("pump and dump" schemes).
The SEC specifically warns investors about penny stocks. Many penny stock promotions are scams — paid promoters hype a stock on social media or email, early holders sell into the artificial demand, and latecomers are left holding worthless shares.
Legitimate arguments for penny stocks include: the possibility of outsized returns if a small company succeeds, and diversification into micro-cap growth opportunities. However, studies consistently show that penny stock portfolios underperform the broader market dramatically over time.
If you do trade penny stocks, never invest money you can't afford to lose completely, use strict position size limits (no more than 1-2% of portfolio per position), and be extremely skeptical of promotional materials.
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Frequently Asked Questions
Can you actually make money with penny stocks?
Some people do, but the vast majority lose money. For every penny stock success story, there are hundreds of failures. Academic research consistently shows that penny stocks as a class have negative average returns after accounting for transaction costs and spreads.
Why are penny stocks so risky?
Limited regulatory oversight, minimal financial disclosure, low liquidity (hard to sell), wide bid-ask spreads, vulnerability to price manipulation, and the underlying companies are often pre-revenue or financially unstable. Many penny stock companies eventually go to zero.