The stock market is a place where investors trade the shares of companies. There are primarily two kinds of shares: common or equity shares and preference shares. Equity share holders enjoy certain rights such as voting, while preference share holders enjoy a preferential right in terms of dividends and liquidation. These stocks are normally traded on formal trading facilities called stock exchanges. Companies who stocks are listed on stock exchanges have to follow the rules and regulations laid down by the Securities and Exchange Commission (SEC). However, there are some companies that may not be in a position to comply with the rules and regulations laid down by the SEC. These companies' stocks trade out of formal stock exchanges. They do business in the Over The Counter Bulletin Board(OTCBB) and in the Pink Sheets. Stocks range in value from $1 to $100,00 or more. Penny stocks are stocks that are priced less than $5. Stocks that trade out of formal exchanges but trade in OTCBB and Pink Sheets are also categorized as penny stocks. Some institutions prefer to use the term penny stocks for companies that have a market capitalization of $500 million or less. Market capitalization is the price value of each share multiplied by the number of outstanding shares. There is no universal definition for penny stock because companies can move in and out of the penny stock region. A company doing very well and listed on formal stock exchanges may suddenly encounter some financial or operational difficulties. As a result of this, the value can drastically go down. When the value goes down, they will be automatically move out of the stock exchanges and they may trade in OTCBB and Pink Sheets. Some good examples of this situation are the stocks of Lehman Brothers, AIG, Freddie Mac, Fannie Mae, and other financial companies that used to trade on the NYSE or NASDAQ. These stocks can now be categorized as penny stocks because of their low value. An important characterization of penny stocks is their low volume of trade. This low volume of trade can give rise to a lot of manipulations and frauds. The price of any stock depends on the demand and supply of the stock. When there is more demand, the price goes up and when the supply is more, then the value of the stock comes down. Any person with an intention to cheat others will buy large volumes of a particular penny stock. As a result, the value of the stock will go up. This can lure other investors to buy more and the price will go up even higher. Finally, the fraudster will dump all the shares after making a handsome profit. This will cause the stock price to crash because there will be more supply than demand. The innocent investors who invested their money can lose a lot and sometimes they may even lose the entire capital. In order to protect oneself, every investor must do a thorough and independent research before investing in penny stocks.
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