There are several definitions of penny stocks. The Securities & Exchange Commission (SEC) definition states that a penny stock is any stock with a value less than $5.
This is by no means a definition used by everyone. Other definitions include stocks valued at less than $1. Finally, any stock that is traded on pink sheets or over-the-counter bulletin board (OTCBB) is widely considered to be a penny stock.
Choosing a broker
Choosing a the right penny stock broker is very important. As penny stock investors often buy a large number of stocks (due to the low cost), it is important to choose a penny stock brokerage that has a commission structure that is favourable.
For example, some stock brokers charge a fee for each share purchased as well as a flat rate per trade. Clearly, this could be very costly if you were purchasing large amounts of penny stocks.
Ideally the best penny stock broker is one with no fees additional fees for purchasing large numbers of shares, a low price per trade and quick execution of trades.
Volatility
Penny stocks can often be highly volatile, offering the opportunity for high returns. Fluctuations of 100% can be seen in a matter of days with certain penny stocks.
Whilst this can clearly result in outstanding returns, it is important to consider the other possible outcome. High volatility can result in substantial losses very quickly.
It is very important to fully understand the risks when investing in penny stocks. Most traders lose money trading penny stocks. Good risk management is imperative.
Penny stocks are not for the faint hearted and are generally only appropriate for investors with a very high risk tolerance.
Cheap to buy
Due to the relatively low cost of penny stocks, they are more affordable to a far wider range of investors. This is plus if you only have a small amount of money to risk.