Penny stocks are defined differently by people, but usually, it is considered any stock whose shares sell for under $5 through over-the-counter services like the OTC Bulletin Board or Pink Sheets. Some consider cheap stocks sold on normal securities exchanges to be penny stocks while others do not consider a stock to be a penny stock unless it can be purchased for less than $1. These are equity shares of small companies that trade in low volumes. Since these are traded in smaller volumes than large company stocks, it can be tough to sell its shares.
Penny stocks are high-risk investments; thus, they are considered risky, where brokerage firms are required to send documents to prospective buyers listing out the risks of them. Since, these are equity shares of small, often unproven companies, thus, their stock prices can fluctuate. Thus, smaller firms are less transparent, and finding out information on small firms can be tough. Another concern arises from the fact that penny stock prices are so low that if a stock sells for just 10 cents a share, even a decline of 1 cent per share amounts to a 10 percent fall in value. Similarly, it can offer high potential gains but usually smaller firms fail than become successful.
Penny Stocks are Susceptible to Market Tampering
Another concern is that investors should be aware of is the potential for fraud and price inflation in the market. Prices of stocks are decided by the supply and demand for stock. For larger shares, with large share volumes, one person usually doesn’t have a huge impact on share prices (with the exception being extremely rich or influential investors like Warren Buffet). A single person with sizable resources can artificially hike share prices by buying shares. The subsequent increase in the price is likely to attract attention from the market and spur more buying, by which time, the original investor takes out money and posts a large profit, while latecomers stand to lose a large portion of investment. Due to poor information, an investor might attempt to spread favorable rumors, misinformation and hype to prop up share prices before a sale.