Penny shares may seem like a good option for anyone who has a limited amount of money to invest and wants to dabble in the stock market. For beginners, it is important to understand the risk associated with buying penny shares. There is no limit to the number of penny shares you can purchase. You are only limited by the number of shares the company makes available to the public. However, you should research a company carefully before diving in and making a large investment.
Penny Stock Defined
The U.S. Securities and Exchange Commission defines penny stock as securities that trade for less than $5 a share. There is no minimum number of penny shares you must purchase, but brokers can require a minimum order amount. If you choose to use an online broker to cut some of the fees, pay close attention to the brokerage agreement. Some brokers charge extra fees for every 1,000 penny shares in addition to the regular commission.
Problems with Penny Stocks
Penny stocks are known to trade infrequently. Once you own them, it may be hard to get rid of them. Finding information about the companies selling penny shares of stock is often a challenge, which makes it difficult to make an informed decision before buying. Companies selling penny shares are not required to file with the Securities and Exchange Commission, eliminating the public scrutiny and regulation associated with stocks represented on the New York Stock Exchange and the Nasdaq. Penny stocks are typically traded on the Over-The-Counter Bulletin Board or in the Pink Sheets exchange, which are not strictly regulated.
There also are a lot of scams associated with penny stocks. Because penny stock investors usually are new to the game, companies and promoters see an opportunity to take advantage of inexperienced investors. There are many success stories about the potential gain available from penny stocks; however, they are seldom true. You can make money with penny stocks, but the results are not guaranteed. If you invest big, there is a chance you can lose big. According to Market Watch, despite the allure of investing in penny stocks, the odds are against you.
Because of the high risk of loss, Congress requires brokers trading penny stock to comply with Section 15(h) of the Securities Exchange Act of 1934. Before trading penny stock, the broker needs written consent from the customer agreeing to the transaction. The broker must provide the customer a disclosure document detailing the risks of investing in penny stocks along with the current market quotation for the particular penny stock. After the sale is executed, the broker is required to send the customer a monthly account statement showing the market value of each penny stock held in the account.
- Nerd Wallet: The Basics of Trading Penny Stocks and the Best Penny Stock Brokers
- U.S. Securities and Exchange Commission: Penny Stock Rules
- Market Watch: 10 Ways to Trade Penny Stock
- MSN Money: 10 Penny Stocks That Paid Off Big
- NASDAQ: The Lowdown on Penny Stocks
- Internal Revenue Service. "IRA FAQs - Investments." Accessed Oct. 21, 2020.
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Jeannine Mancini, a Florida native, has been writing business and personal finance articles since 2003. Her articles have been published in the Florida Today and Orlando Sentinel. She earned a Bachelor of Science in Interdisciplinary Studies from the University of Central Florida.