What are penny stocks?

As the name suggests, penny stocks are stocks that are trading for a few penny’s. The official definition determined by the SEC is all stocks that are trading below $5 are penny stocks. Some people find penny stocks attractive. This is mostly based on psychological reasons rather than fundamentals. If you buy penny stock shares, you can buy a lot of shares for a small amount of money. Making it look like you own a lot. Would you rather have 10.000 shares from company X or have 2 shares from company Y? Would you rather have $100.000 right now or $2500 each month for the next 20 years?

Large numbers can be a psychological pitfall making you think you own a lot, or buying something cheap while in reality it’s just a psychological trick. Ever wondered why many products have price tags like $9,97 $4,99 or $19,99 ? Because of the simple reason $19,99 seems less than $20 so people will buy the product more often. While in reality $19,99 and $20 is the exact same value. 

On the other hand, small companies which have a very low share price have the potential to grow very fast. Penny stocks can give much higher gains versus stocks form bigger companies but that also induces high amounts of risk. 

Penny stocks are from small companies that are not listed on major exchanges. Penny stocks are typically traded over the counter (OTC). Meaning the transaction is direct between two parties without an intermediate (exchange). Stocks that are trading OTC typically have low liquidity and less regulations. It also may be hard to find any information about the financials of the company. Since fundamental analysis is crucial for making the right investments, penny stocks are considered highly speculative. That does not mean penny stocks are bad investments but you need to do your homework before buying.