Penny Stocks

What are Penny Stocks? In Depth, but Simple Explanation!

What are Penny Stocks? In Depth, but Simple Explanation!

So I sorted out searches by volume and I got my first task – to answer first question people type about penny stocks into Google which is very straightforward “what are penny stocks?”.
So what I did first, I took two explanations given by Investopedia and SEC websites. I took the commonalities for the provided term and got into more details.
So the main points when answering the question “what are penny stocks?“.
Penny stocks are small companies’ stock. This is very true and to be more exact there is financial lingo term to describe small companies’ size by market capitalization. Professionals call small stocks as small cap stocks. And there a smaller bracket – nano cap stocks and micro cap stocks which are even smaller than small cap stocks.
So when you talk about penny stocks most of the time you talk about nano cap stocks, sometimes micro cap stocks (stocks with market capitalization under 300 million dollars). Why is that? Because size is directly linked the amount of share outstanding which directly links to amount of floating shares.
Now to get to the core the amount that can be traded on an open market is called float or shares float.
So when you have small size company with the small amount of shares outstanding which give us an even smaller amount of floating shares (but not always) this gives us as the result – a small supply of stock. So when we have a small supply of stock and event with high demand for that stock we encounter crazy price volatility which is what penny stocks are well known for. Put simply they are known for huge price swings which are known as volatility. Basically, too many participants are chasing too few stocks so this makes price of a penny stock to move 20%, 50%, 100% or even bigger % per day!!!
But remember that huge volatility is double edge sword – it can provide insane gains but it comes with higher risk.

Penny-Stocks-chart

Penny stocks have a low price. This is true and it is one of the features of a penny stock but not always while even penny stocks trade for pennies or few bucks it sometimes doesn’t end up only at these levels. Penny stocks can even be traded for 10 or 20 dollars per share. What helps to increase this price so drastically? It is the supply of a stock. So again we get back to first point that size matters and only low supply can make such insane moves possible.
BTW Ford motors traded for 1.5$ after 2008 crash. Can we consider this company small? Of course not, so the price is just one of the features of a penny stock.
Penny stocks mostly trade OTC (over-the-counter). Yes, on OTC markets you can find many many penny stocks, but as well I need to tell you that there is as big amount of small companies that trade on regular stock exchanges. And this is what I would recommend to everyone interested in trading small companies – trade nano and micro cap stocks on regular stocks exchanges, while exchange-traded penny stocks are more regulated, have better liquidity and it is easier to find a decent broker to trade them. As well stock that trades on regular stocks exchanges need to disclose more information to the public regarding it financial performance. You get the point! If you are interested in this niche trade penny stocks on regular stock exchanges. Let’s get back to the point now.
Why small companies tend to choose to be listed on OTC markets? Simply due to lower capital that is needed to be listed there and as well because companies need to satisfy less listing requirements than when listing its stock on a regular stock exchange.
BTW because OTC markets have minimum standards for stocks to be listed there is more cases of stock fraud happening there, so remember this.

So what are penny stocks?
To summarize here, penny stocks are stocks of small companies that are highly speculative. Penny stocks are being traded OTC and on regular stocks exchanges. They have low price and low supply of a stock which makes them very volatile.
Now to finish here, I personally think that the main denominator of a penny stock is the size of the company and its market capitalization. Even other points are valid and get us extra features nothing better defines a penny stock as the size of the company and its market capitalization. Period!

Last words
Now if you are interested in fast moving stocks and you like to be in the epicenter of a new emerging and trending industries like marijuana or blockchain industries, this is where it all starts. Micro and nano cap stock niche and in general small cap stock niche is the place to be.

Posted by Judy Romero in Investing, Investment, Stock, Stock Market