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Tue, Feb 16 2010 - 11:21 PM

The Basics about Penny Stocks

You may have heard about these penny stocks and wondered exactly what they were. If you have had an email address in the last ten years then it is likely that you have seen email advertisements that are touting some penny stock and telling you that you can strike it rich for very little money down.  These kinds of scams exist in many different areas of life these days and have become prolific because of the internet.  They have given penny stocks a bad rap and it is not a true indication of what they are.

Penny stocks get their name from the low issue price.  It is not to be taken too literally, though.  They are rarely a penny, although it is possible.  Their per-share value is capped at $5.  There are some out there that define penny stocks in different ways such as market capitalization but this is not really accurate.  While it is true that penny stocks are almost invariably small capital companies this does not mean that it is how they are defined.  It is more likely that they fall into this category due to smaller capital but the Securities and Exchange Commission gives the stock price as the indicator.

So you might ask what is really the difference, and why would they have another category of stocks?  Really, the thing that sets penny stocks apart from other stocks is where they are sold.  Most of the stocks in companies that you are familiar with are sold on large stock exchanges like the New York Stock Exchange or the NASDAQ.  Think of companies like General Motors or Coca Cola and you get the idea.  You might not have heard of every company on these exchanges, but they are all large enough and offer enough stock to be there.  They are also governed by the SEC and are watched much more closely with respect to financial reporting and transparency.

The penny stocks themselves are not governed by the SEC, but the brokers are.  There are certain things that they are expected to do and in fact required to do.  Technically they are not to solicit penny stocks, but must receive an order for stock from the buyer.  The broker should always provide the advice that they have given you in writing, and they are required to send you a written report every month that makes it clear what you are holding along with the current price of the stock.  It is wise to do a little checking with the SEC when it comes to your broker.  You don’t want to find out after the fact that they have been disciplined for breaking these rules.  There is no need to learn a hard lesson this way.

These penny stocks are traded on the over-the-counter market and they are not always that easy to find.  The over-the-counter market is basically for those companies that do not meet the minimum standards to be on the major exchanges.  They are sold by brokers, usually who deal primarily in this market.  

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