What Exactly are Penny Stocks?

The definition of a penny stock is a stock that is priced below $5. These stocks tend to be issued by emerging companies looking for funds to finance their growth plans. When investing in penny stocks, the investor must be able to differentiate between the stocks of emerging companies and stocks of former high-flying companies that have fallen from grace. To boost the likelihood of generating good returns from penny stock investing, the investor should focus on the former.
A young public company whose shares are priced below $5 is likely a small cap company. A small cap company is defined as a company whose market value is no more than $2 billion. Growth investors are attracted to these companies because of their potential to expand many times over. After all, it is easier for a company with annual revenue of $200 million to grow many times over than a corporation with $20 billion in annual revenues.

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Because of its small share float, the price of a penny stock can fluctuate greatly. A rush of buy orders can greatly push up the share price while sell orders can significantly push down the price. The penny stock investor needs to be prepared for high price volatility. The seasoned equity investor knows that high returns come with high volatility.