What is Penny Stocks & How does it work?

A penny stock is a stock in a tiny business that trades for less than $5 a share, and it is often referred to as such. Although some penny stocks are traded on big exchanges such as the New York Stock Exchange (NYSE), the vast majority of penny stocks are traded over-the-counter (OTC) via the electronic OTC Bulletin Board (OTCBB) or through the privately held OTC Markets Group.

Key Points Briefly

• In the financial world, a penny stock is a stock of a tiny business that usually trades for less than $5 per share.

• Although some penny stocks are traded on big exchanges such as the New York Stock Exchange (NYSE), the vast majority of penny stocks are traded over the counter via the Over-the-Counter Bulletin Board (OTCBB).

• In addition to the potential for substantial profits from trading tiny stocks, trading penny stocks has the danger of losing an equivalent amount of money in a very short period of time.

Penny Stocks − What are They and How They Work?

In the past, penny stocks were defined as any equities that traded for less than one dollar per share at the time of purchase. The Securities and Exchange Commission (SEC) of the United States has amended the term to cover all shares trading for less than five dollars a share.

In most cases these penny stocks are linked with tiny businesses that trade rarely, indicating the lack of liquidity or willing buyers in the market for them. It may thus be difficult for investors to sell their stocks since there may not be any buyers available at the moment.

Example of Penny Stock Fraud in the Real World

During the period between 2008 and 2013, a California man named Zirk de Maison established almost half a dozen shell corporations and sold them to investors in the form of penny stocks, according to the Federal Bureau of Investigation (FBI).

Investors were led to believe that the firms were involved in a range of industries, such as gold mining and diamond dealing, while in reality they were not engaged in any of these activities.

He marketed the stocks in "boiler rooms," which are places where brokers utilize severe pressure methods to get customers to invest in stocks by promising them maximum returns in exchange for their money. A federal jury convicted de Maison and seven other offenders guilty of securities fraud in 2015, and they were sentenced to federal prison.