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One of the least well known aspects of investing is investing in penny stocks.  Many investors misunderstand the definition of a penny stock and either avoid them like the plague or increase their shares of penny stocks to the point where they could be a dangerously high percentage of their portfolio.  If you are interested in purchasing penny stocks to add to your holdings, there are a few things that you should understand first.

What Is A Penny Stock?

A penny stock, as defined by the Securities and Exchange Commission (SEC), is a stock that is sold as low priced shares of a small company.  These shares are generally sold outside of the stock exchange and are traded infrequently.  The people that purchase these shares are often lured with the prospect of making significantly more than the initial investment in a short period of time with a company that could become well-known in the future.

There are a number of different types of companies that are traded in the penny stock market.  Some of the shares are from out of favor stocks or companies that are entering or emerging from a bankruptcy.  Other shares come from speculative entities that are legitimate, but are too risky for more cautious investors.  There are some fraudulent companies and entities that also trade shares on the penny stock market, but by researching the underlying companies before purchasing any stocks, savvy investors should be able to avoid those that are fraudulent in nature.

Pricing Penny Stocks

It can be difficult to find accurate price quotes for a penny stock because the small companies that are offering the shares are not evaluated by the same regulators that monitor and valuate the larger corporations.  Some of the newsletters that are issued to prospective investors with penny stock price quotes are inventing the prices themselves or attempting to artificially inflate the price of the stock so that the owner’s holdings will be more lucrative, resulting in a “pump and dump” scheme.  It is important for potential investors to research and obtain accurate information on the companies that they are considering investing in so that they can make an informed decision on the best types of stocks to purchase for themselves.

The Risk Of Investing In Penny Stocks

Investors that invest in penny stocks are at a higher risk of losing their entire investment than the investors that purchase the more expensive stocks that are traded on a stock exchange.  The companies that trade their stocks as penny stocks have less capital to call on in the event of a catastrophic incident and so are at greater risk of bankruptcy or closure if something goes wrong.  Although the investor may be able to obtain a high rate of return for their initial investment in the penny stock, they may also lose their investment in a very short period of time if the company does not do well.