Penny Stocks are stocks that are priced at less than $5 and the total market capitalization (price per share multiplied by the number of shares) of the company is less than $5 million. These shares are traded outside stock exchanges in electronic quotation systems called Over The Counter Bulletin Board (OTCBB) and Pink Sheets Securities. These electronic systems play an important role in bringing the buyer and the seller together. They display the latest price of each share, average volume of transactions, bid price and ask price. Bid price is the price at which a buyer is willing to buy the shares and ask price is the price at which a seller is willing to sell the shares owned by him or her. Penny stocks do not trade in stock exchanges because they may not be in a position to fulfill the minimum requirements that have to be followed to be listed on the stock exchanges. These requirements are laid down by the Securities and Exchange Commission (SEC). The reasons for the non-fulfillment can vary from company to company but the most common reasons are financial and operational limitations. Penny stocks are traded through a network of dealers. Many times a deal is completed through the phone or Internet. Any investor wishing to buy or sell penny stocks has to contact a broker. The broker will act as an intermediary to execute the transactions on behalf of the investor. Investors can start by opening a brokerage account with any brokerage firm of their choice. These brokers make money by spread. Spread is the difference between the bid price and the ask price. For example, if the bid price is $0.20 and the ask price is $0.50, then the buyer will pay $0.50 for every share. The difference of $0.30 is the spread and this is the commission that the broker will take. The spread can range from 30% to even 100%, depending on the share and its price. So, investors must be aware that there is a built-in loss associated with penny stocks. But there are some shares that trade with small spreads and in some rare cases, it may be worth to buy a share at even a slightly higher price because of the expected rate of return. However, the investors must be aware of what they are getting into. In some cases, the brokerage firms may have an inventory of many penny stocks companies. As soon as an investor wishes to buy a certain number of shares of a particular company, the broker will immediately transfer the shares from the inventory. This normally happens within a few seconds itself. The price of these shares will include a pricing factor called markups. Brokers will mark up the price of shares by a certain percentage, over and above the spread. This is because the shares are subject to market fluctuations and they would like to insulate themselves from these variations. Therefore, an investor must be conscious and aware of the pricing factors involved in penny stocks before buying them. This may help them to make a better decision.
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