Understanding the Penny Stock

Before you can begin investing in penny stocks, you do need to take the time necessary to find the right knowledge base for the process.  That is, you need to understand what the penny stock is as well as how you can invest in them.

What Is A Penny Stock?

The first order of business here is to define just what the term; “penny stock” refers to.  The bad news is that there are many mixed definitions out there regarding what this type of stock actually is.  Therefore, you need to understand what things are considered to be penny stocks and then how to determine what the stock really is.

For example, a penny stock is a common term used to describe a stock that is inexpensive to purchase per share.  This could mean:

• A stock that is priced under one dollar per share
• A stock that is priced under five dollars per share
• A stock that is traded on what is called pink sheets
• Any over the counter, or OTC, type of stock

The United States Securities Division says that a penny stock is one that is valued under the value of five dollars and is traded either on pink sheets (over the counter) or on the NASDAQ. 

Value Counts

What you should know is that a company that trades with penny stocks is a company that has a value that is quite low in comparison to other companies.  It should have a net worth that is four million dollars or less in net tangible assets.

In other words, companies that are valued higher than this amount, those that have more inventories, for example, are those that regularly trade on the stock market.  Those companies often have a good amount of history being up and running. 

In addition, they usually have what is called heavy assets.  This means that the company has a good amount of real business as well as solid equipment and a good amount of inventory.  They are usually set in what their business is as well.

You will find that these companies are those that have fewer inventories, less sales, and are more commonly unknown than those companies that are traded on the stock market regularly.  Of course, that’s why they are called penny stocks.  In addition, these companies generally do not carry a large amount of business from one quarter to the next.  They may not even have defined goals or a solid business inventory as of yet.

Terminology

One thing that makes penny stocks so, well, frustrating to learn about is that they are often called by various different names.  You may have heard them referred to as micro stock, nano stock, micro cap stock, small cap stocks and many other names.  If that sounds confusing, just remember that they are generally all terms that rely simply on the fact that the stock is priced below a dollar to five dollar range.  In other words, penny stocks are quite affordable, low costing stocks.

Where They Trade

The stock markets like the New York Stock Exchange have very strict rules about which companies can actually trade on them.  In addition, they monitor the company for what it is before allowing the company to be traded.  What does that mean?  It means that companies such as those that trade with penny stocks do not meet the criteria of the stock market to the degree that allows them to participate.

In other words, companies that trade in penny stocks do not necessarily have the assets, the business history or the net worth to be traded on the New York Stock Exchange or on other stock markets.  Thus, they must be traded elsewhere.

Penny stocks are not traded on the stock market but they are still traded.  In fact, they are traded as part of what is called the OTC.  OTC stands for Over the Counter markets. 

OTC markets can be part of the NASDAQ which is the National Association of Securities Dealers Automated Quotation.  The NASDAQ National Market or NNM is made up of part of the OTC market. 

Yet, there are some changes there, too.  Often, the NASDAQ changes its rules, so to speak, allowing in penny stocks when they did not.  Or, they may decide to change from allowing to not allowing any longer.  Needless to say, the number of penny stocks that are on the NASDAQ in any given time changes readily. 

So, at this point, you know that you can purchase penny stocks on the OTC markets. These would be non-NMN penny stocks. In addition, you can purchase them through some parts of the NASDAQ market as well.  In just a minute, we will touch on the third method of investing in penny stocks besides these two methods.

The Benefits of NASDAQ

Not all penny stocks are traded on NASDAQ that much you should know for sure.  But, if you were to purchase stocks that are traded on this market, you should know that NASDAQ does provide for a good amount of regulation.  That means that they do monitor the companies that are on their market as well as insure that they meet certain criteria before letting them change hands on the market.

In addition, there are some real benefits to working with the NASDAQ penny stock.  For example, not only do they meet the specific requirements that the NASDAQ has in place, but they also provide for the ability to easily track those penny stocks.  That’s because the stocks traded on this market are reported at least weekly in many local newspapers. 

This lets you easily track what is happening with the stock that you have purchased.  The benefit here is that you do not have to contact your broker to learn about what is happening with your penny stocks.

Pink Sheet Investing

As mentioned, there is a third method to investing in penny stocks that you should know all about.  That is what is called pink sheets.  The pink sheets are actually a part of the OTC market.  It is technically called the National Quotation Bureau’s or the NQB. 

This area of the penny stock market needs to be dealt with carefully.  In short, it is less simplistic to handle and here is why.

• There are no necessarily strict listing standards applied to those penny stocks.

• There is little to no information available about pricing, as it is difficult to learn.

• They are called pink sheets because all of the information including lists and prices are printed onto these narrow sheets that are generally pink in color.  That’s about as accurate as you get here.

• The average investor has a hard time learning necessary information about them.

• If you work with a broker with pink sheets, you should not have as much of a problem obtaining the necessary information.  They can contact what is called the market makers to get necessary information on them.

• The small investor without connections will have to rely on their stock broker for all necessary information about the penny stock that they are trading.

As you can see, trading penny stocks can be something of a risk simply from the way that they are set up.  Yet, the investor that is educated and knows just what is needed to make the sale can do so with the help of a qualified stockbroker, something that we will talk about in later chapters.

It is essential for anyone that is interested in selling penny stocks to contact and work with a trustworthy stockbroker to insure the deal goes well.

Although it may sound as if we are being negative about this type of trading arrangement for penny stocks, it is not so much that it is negative, just a fair warning. 

The different types of markets that you can invest in for penny stocks is important because you need to see the difference in the way that the stock is traded as well as the difference in the way that it is placed onto the market.  This plays a very important role in just how likely it is for a stock to be risky for you as well. 

Those that are looking for a less risky option should take into consideration working with a NASDAQ based stock.  Those that are looking for improved risk may not be okay with the high amount of risk that is posed by a penny stock in the first place.  Nevertheless, if you are seasoned enough or looking for a huge windfall that plays on huge risks, then investing in OTC stocks through the pink sheets should be considered.

In the following pages, we will talk more about determining your level of risk as far as penny stocks are concerned.