3 things characterize penny stocks: low price (a security issued by a very small company that trades at less than $5 per share), small-cap (small market capitalization) and they trade over the counter through the Over-the-Counter Bulletin Board and pink sheets (outside major market exchanges).
Another important feature of penny stocks is the lack of liquidity, which makes them speculative and risky. These companies are not among the most regulated and their listing requirements are limited.
You can buy penny stocks through your regular broker (it doesn’t matter if they’re not listed on major market exchanges).
Gains and losses can be impressive when trading penny stocks, the question is do you have a high tolerance for risk?
Even if you do, due to their high risk nature, you should walk very carefully on penny stocks territory. For example, set up a stop-loss order, be realistic (it is very unlikely that you will become a millionaire within a couple of weeks starting off with $200), disregard any emails with the subject Best Penny Stocks or Penny Stocks To Watch, stay away from pink sheets (try to focus on penny stocks listed on Nasdaq and AMEX).
There’s a list of reasons why penny stocks are risky: information (more precisely lack of it), reporting standards, history, liquidity.
If a penny stock trades on the New York Stock Exchange, American Stock Exchange or Nasdaq the risk is significantly lower compared to a penny stock that trades on the OTC or the pink sheets, because of reporting standards. Companies on major market exchanges have reporting standards and obligations with their investors. Regulations for companies on OTC and pink sheets are almost non-existent.
Another major problem is liquidity and you don’t want liquidity problems, it doesn’t matter if you have the top penny stocks to buy list (or if you think you have it) because you might end up sticked to bunch of worthless unsalable stocks.
Sure enough, penny stocks can very risky and, sure enough there are hot penny stocks out there that can pocket you good money. Follow these simple rules that will help you trade safely: