The Securities and Exchange Commission (SEC) defines a penny stock as a speculative security valued under $5 per share and offered by a small company. This definition has been stretched to cover all speculative stocks with share values near $5 that are traded outside of the major stock markets. Investors who trade in penny stocks know that their daily dealings rest on a razor's edge. While the upward potential of a penny stock is tempting for day traders, the speculative nature of penny-stock trading means that one day's profits can be swept away with a bad jobs report or FDA rejection of a new product the next morning.
Business Week's Gary Weiss wrote an article in 1997 warning investors against "chop stocks." This nickname for penny stocks implied the massive markup used by brokers to generate profit off speculative investments offered to their clients. Weiss noted that the "chop stock" phenomenon was a $10-billion-per-year business. The Internet is filled with advice pertaining to penny stocks, including "sure-fire" investments and subscription services offering daily tips. Novice investors should dig deeper into penny-stock advice and over-the-counter brokers to determine if their personal information is safe before sending their money into the digital abyss.
An investor interested in penny stocks should consider the state of his current portfolio, as well as the recent history of a company, before investing. If a portfolio is heavy on an industry like pharmaceuticals or telecommunications, an investment in dozens of shares in a penny stock would be unwise. Investors can use penny stocks to diversify their portfolios while trying to make quick profits, hedging their bets in long-term stocks with speculative investments. While most market experts ask investors to look at a 12-month pattern before buying a stock, penny stocks are either startups without strong reputations or established companies that have fallen on hard times. The typical 12-month analysis should be substituted for a 30-day review before investment decisions are made on penny stocks.
Outlets for Penny Stock Picks
Since penny stocks are often sold outside of major exchanges, investors need to look at "over-the-counter" listings to find these speculative opportunities. The OTC Bulletin Board is a popular resource for penny-stock investors, offering quotes on a minute-by-minute basis and a transparent set of listing rules for OTC stocks, which separates this medium from standard exchanges. While OTC Bulletin Board is merely a middleman between investors, their financial advisers and listed companies, it is as honest a resource as can be found on the Internet for penny-stock information. The Motley Fool's CAPS website is another good resource for penny-stock picks, because it is filled with informational articles and daily analysis of OTC stocks.
Regulations on Penny Stocks
The Securities and Exchange Commission regulates penny stocks offered through OTC traders in the United States. The SEC acts as an intermediary between penny-stock investors and companies by handling oversight over the trading process. To offer penny stocks for sale through trading platforms, companies have to submit monthly pricing statements on penny-stock values to their investors. Before each trade is complete, the SEC requires investors to submit an agreement to purchase stock from the company in question. While the SEC oversees the trading process for penny stocks, it does not guarantee the regularity and value of the stocks in question.
Searching for Emerging and Recovering Industries
Newcomers to penny stocks should look for shares in industries that are in flux, as well as startup companies in high-demand industries. For example, the stocks of the Big Three automakers in the United States have fallen into penny-stock territory due to financial instability and an inability to compete with foreign automakers. Penny-stock investors should review the profiles of all three companies and make an investment in the most stable company, anticipating an upward swing as the economy improves. While green energy and information technology remain hot markets, investors interested in penny stocks with great upward potential should look at up-and-comers in the pharmaceutical industry. Anadys Pharmaceutical Inc. is a developer of hepatitis and cancer treatments that remains in penny-stock territory but has grown 175 percent since 2007.
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