What Penny
Stocks Are?
There are
thousands of companies whose shares are traded by investors.
One segment of shares are called penny stocks. As the name
implies, penny stocks are priced much smaller, usually less
than $5, and they trade outside formal stock exchanges. They
trade on Over The Counter Bulletin Board (OTCBB) and Pink
Sheets.
Section 3(a)(51) of the Securities and Exchange Act of 1934
defines penny stocks to be stocks that are traded outside any
national securities exchange, that is priced less than $5, and
the market capitalization (price of each share multiplied by
the total number of shares issued) should be less than $2
million if the company has been in operation continuously for
the last three years and $5 million otherwise.
So, why was $5 chosen as a benchmark to categorize companies as
penny stock companies? There are three main reasons for this
categorization. The first reason is the inherent difficulty in
manipulating stocks that have a high value. When the value is
more than $5, the actions of one or a handful of investors will
not cause a big swing in prices and so they cannot be a penny
stock. The second reason is that $5 per share is the limit for
ULOR/SCOR.
They are the state registration
forms for companies that are planning to raise less than $1
million under Regulation 504. The final reason for this
threshold limit is to help investors understand that some small
business may be legitimate and they can move out of penny stock
territory in future. In other words, investors must know that
not all penny stocks are illegal or fraudulent. There may some
gems that can glitter in the long run.
As mentioned above, not all penny
stock companies are bad. There can be some companies that have
started small and can make it big in a few years. A good
example is a company called Arcelor Mittal (NYSE: MT). This
company was priced at $0.89 a few years back and it soared to
$104 in 2007. So, any investor who had spotted this company at
$0.89 would have made millions of dollars by 2007. Investors
should be alert for such companies.
There are many kinds of frauds and
scams associated with penny stocks. One common type of fraud is
called Pump and Dump. Any fraudster with the intention of
defrauding others to make money, will buy huge volumes of a
penny stock. Due to their low volume of trade and their low
value, this will boost the value of the stock. Other genuine
investors, believing that the company is doing well, will
invest more money and will buy the shares of this penny stock
company.
As a result, the value will go up
even further and the fraudster will dump all of his or her
shares. This will crash the price of the shares and the genuine
investors may lose a lot of money and the entire capital in
some cases. So, extreme caution must be exercised by the
investor.
Nir Dotan is a writer and promoter
of cutting edge companies such as http://www.4yellowads.com
around the world.
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