Investing in Penny Stocks

Not all stocks fulfill listing requirements for major stock exchanges like Nasdaq and NYSE but they trade on over the counter market (OTC). Even though many believe penny stock trade less than a $1 per share, Securities and Exchange Commission defines them as a securities issued by small-cap and micro-cap companies that trade under a $5 price.

Because of their low price penny stocks are often logical beginning for new investors. What this means is that you can buy thousands of shares of various companies without investing significant financial means. You may even hear from some investors that they joined "one million club" owning million shares of the same company trading on OTC. With such big numbers of shares, price raise of even few cents can bring nice gains for investor. Some may be attracted to penny stock because they are dreaming of big profits, buying shares for couple of cents and selling them for millions. Even though penny stocks can be lucrative there are certain pitfalls that give them a bad reputation. Such stocks are considered highly speculative, lacking in liquidity, with small market capitalization and limited disclosure. Large bid ask spread is indicator of low liquidity. It shows that difference between what is buyer willing to pay and for what is seller willing to take is big enough to trap your shares or even weeks before you are able to sell them.

Over the counter market is decentralized market where trading is done directly between parties but lacking the same level of transparency and regulation that characterize exchanges. OTC Market Group provides market place for more than 10,000 securities organized in three tears that provide different levels of transparency. Excluding OTCQX other two markets include penny stock trading. OTCQB includes early stage and developing companies that must be current in their reporting and meet certain requirements but it has no minimum financial standards. The last tier OTC Pink is the most speculative with no disclosure requirements. Pink sheets are further divided in three segments; OTC pink current report include companies that provide quarterly and audited annual reports, OTC Pink limited information have filed quarterly and annual reports within the past six months and OTC Pink no information for companies which haven't submitted any kind of information in the past six months. If you are interested in investing in penny stocks you can use stock screener to filter stocks based on set criteria which depends on your investing strategy and risk tolerance.

When opening trading account be fully aware of fee structure. Knowing exactly how every service is going to cost you will help you avoid unpleasant surprises and better understand impact that fees will have on your final return. Part of that process is choosing the right broker as they specialize in different areas and charge commission on different basis. Investing in penny stock usually means buying large number of securities so brokers charge commissions on per share basis may not be the most suitable.

Reputation that penny stocks have doesn't mean that there aren't any good companies that trade on OTC. Yes, they are probably new in the industry with few products and services but some of them have potential to grow and become bigger. But, you still need to protect yourself from risk and the best way to do is to conduct a research (due diligence). Sure you will find many stock picks and recommendations but you need to confront stories you hear with facts. It is not bad idea to call company's investor relation in order to seek additional information or confirm the ones that you heard.There is array of indicators  that can help you determine whether certain stock is going to perform well in the future. Good indicators can be positive earnings and industry news, new partnerships or increase in trading volume wile others like toxic financing, poor industry news and lack of trading volume are considered negative signs. Creating your own watchlist will help you keep track of promising stocks.