What is the Definition of Penny Stocks?
Definition of Penny Stock
Defining a penny stock is not as simple as it sounds. There are no hard fast rules on what defines a penny stock. It largely depends on who you are talking to at the moment. There are a number of guidelines for determining what are penny stocks. To assist in classifing a security as a penny stock, an investor can use the following rules of thumb: (1) the security's value is less than $1, (2) the security trades over-the-counter (OTC) and (3) the security's market cap is less than $15 million.
Penny Stock Value
The $1 dollar threshold is the literal meaning of a penny stock as its value is based in cents. However, the SEC classifies penny stocks as securities which trade below $5 per share. While there is a constant debate over value, if a trader is looking at a stock valued at .50 cents, there simply is no question.
Where are Penny Stocks Traded
Penny stocks are most commonly traded on the over-the-counter-bullentin (OTCB) market. This market is also known as pink sheets, due to the fact that prior to electronic markets, the thinly traded stocks on the OTCB were listed on pink sheets. The reason so many penny stocks are listed on the OTCB, is because many small companies do not meet the requirements for being listed on the major exchanges.
Penny Stock Market Cap
When companies have a small market cap, they are considered riskier investements. This is because the lower the market cap, the less interest there is in the security. We often here of market cap, and how it is important, but what does it mean to an investor? Let's look at a real-life example. If a stock has a market cap of $1 million dollars and it is trading at .50 cents, this means that there are 2,000,000 shares in float. With only 2M shares in float, how could a day trader get in and out of a position? It would be possible, but with only 2M shares in float the trading volume on the security would be extremely light. This would create an environment with a huge bid/ask spread, making it extremely challening to get in and out of a position.