About Penny Stock
A penny stock alludes to a little company's stock that commonly trades for under $5 per share. Although some penny stocks trade on large exchanges, such as the New York Stock Exchange (NYSE), most penny stocks trade by means of over the counter (OTC) transactions.
Transactions occur through the electronic OTC Bulletin Board (OTCBB) or through the privately-owned Pink Sheets. There is no trading floor for OTC transactions, and the quotations are likewise done electronically.
Explained Penny Stocks
Previously, penny stocks were viewed as stocks that traded for less than one dollar for every share. The U.S. Securities and Exchange Commission (SEC) has adjusted the definition to incorporate all shares trading under five dollars. The SEC is an independent federal government agency responsible for ensuring investors they keep up reasonable and precise working of the securities markets.
Penny stocks are generally connected with small companies and trade. This means they have an absence of liquidity or prepared purchasers in the marketplace. Subsequently, investors may think that it’s hard to sell stock since there may not be any purchasers to buy them. In light of the low liquidity, investors may have difficulty finding a value that precisely mirrors the market.
Penny Stocks Price Fluctuations
Penny stocks offered on the marketplace are frequently developing companies with restricted money and assets. Since these are fundamentally little companies, penny stocks generally attract investors who have a high capacity to bear the risk. Normally, penny stocks have a more significant level of instability, bringing about a higher potential for remuneration and a more elevated level of inherent risk. Investors may lose their whole investment on a penny stock, or more than their investment if they buy on margin. Purchasing on margin implies the investor borrowed funds from a bank or broker to buy shares.
Considering the uplifted risk levels related to putting resources into penny stocks, investors should play it safe. For instance, an investor ought to have a stop-loss predetermined before entering a trade and recognize what value level to exit if the market moves inverse of the planned bearing. Stop-Loss orders are guidelines put with the broker that set a value limit that will trigger an automatic sell of the securities.
In spite of the fact that penny stocks can have dangerous moves, it is important to have reasonable desires whereby investors comprehend that penny stocks are high-risk speculations with low trading volumes.
Penny Stocks Risks
Penny stocks do give some small businesses a way to access funding from people in general. These companies may utilize this stage as a beginning block to move into a bigger marketplace. In addition, since they sell at such low costs, there is space for a noteworthy upside. However, a few variables compound the risk related to contributing or trading penny stocks. The securities are usually riskier than companies known as blue-chip stocks.
A blue-chip is a nationally recognized, well-established, and monetarily solid company. Blue chips by and large sell high-quality, generally acknowledged products and services. Blue-chip companies ordinarily have a background market by enduring downturns and working productively even in unfavorable economic conditions, which strengthens their long record of steady and dependable development.
Reasons on Failed Penny Stocks
Lacking Information to the Public
It's significant with any successful investment techniques to have enough information to make an educated decision. For penny stocks, information is significantly more hard to track down when contrasted with settled companies. Moreover, accessible
information about penny stocks may not originate from credible sources.
Stocks traded on the OTCBB convey the "OB" suffix to their symbol. These companies file financial statements with the SEC. However, companies recorded on the pink sheets are not required to document with the SEC. As such these companies don't get a similar open investigation or directed as the stocks represented on the NYSE, the NASDAQ, and other markets.
No Minimum Standards
Stocks on the OTCBB and pink sheets don't need to satisfy the least standard prerequisites to stay on the exchange. When a company can no longer keep up its posting position on one of the major exchanges, the company can move to one of the smaller OTC listing exchanges. Minimum standards function as a security cushion for certain investors and as a benchmark for certain companies.
Lacking History
Huge numbers of the companies viewed as penny stocks could be newly formed, and some could be moving toward bankruptcy. For the most part, these companies will have helpless track records or no reputation at all. As you can see, this absence of historical information makes it hard to determine a stock's potential.
Fraud and Liquidity
Stocks that trade rarely don't have a lot of liquidity. Subsequently, it is conceivable that investors won't have the option to sell the stock once it is gained. The investors may need to bring down their cost until it is viewed as alluring to another purchaser.
Low liquidity levels give chances to certain traders to control stock costs. The pump and dump scheme is a well-known trading scam to seduce investors into purchasing a stock. A lot of a penny stock is purchased following a period when the stock is hyped up or pumped up. When other investors race to purchase the stock, the scammers sell or dump their shares. When the market acknowledges there was no major explanation behind the stock to rise, investors hurry to sell and take on losses.
Pros
- Offer an opportunity for small companies to obtain access to public funding.
- In not many cases, penny stocks may help access larger marketplace listings.
- With a lower value, penny stocks take into account a significant upside in share appreciation.
Cons
- Penny stocks lack a liquid market with few purchasers, perhaps considerably after their increased price.
- There is restricted information accessible on the company's financial soundness or track record.
- Penny stocks have a high probability of fraud and bankruptcy of the underlying company.
Fraud Signs
Though there is no fool-proof defense with penny stocks, the SEC suggests that investors mind the accompanying notice signs: SEC trading suspensions, spam, huge resources yet little incomes, financial statements containing unusual things in the commentaries, odd auditing issues, and enormous insider proprietorship.
Penny Stock Fraud Real World Example
A resident of California, Zirk de Maison made almost 50% of twelve shell companies and offered them as penny stocks to investors somewhere in the middle of 2008 and 2013, as indicated by the Federal Bureau of Investigation (FBI). De Maison told investors that the companies occupied with an assortment of businesses, some of them are gold mining and diamond trading when they didn't do anything. He sold the stocks through "boiler rooms," workplaces where brokers utilize high-pressure strategies to drive individuals into purchasing stocks by promising enormous benefits, stealing $39 million. In 2015, de Maison and seven different culprits were seen as blameworthy of securities fraud and condemned to federal prison.
Creation of Penny Stock
Small companies and new companies typically issue stock as a method for raising money to develop the business. In spite of the fact that the procedure is protracted, giving stock is one of the fastest and best ways for a new business to acquire capital.
A penny stock, similar to some other traded on an open market stock, is made through a procedure called an initial public offering or IPO. To be recorded on the OTCBB the company should initially document an enrollment proclamation with the SEC or record showing that the contribution meets all requirements for exclusion from enlistment. It should likewise check state securities laws in the areas it intends to sell the stock. When endorsed, the company may start requesting orders from investors. The company can apply to have the stock recorded on a bigger exchange, or it can trade on the over-the-counter market or OTC.
Penny Stock Underwriting
As with other new offerings, the initial step is hiring an underwriter, normally a lawyer or investment bank specializing in securities offerings. The company's offering either should be enrolled with the SEC as indicated by Regulation A of the Securities Act of 1933 or file under Regulation D if absolved. On the off chance that the company is required to enlist, Form 1-A, the enrollment proclamation, must be recorded with the SEC alongside the company’s financial statements and proposed deals materials.
The budget reports need to stay accessible to people in general for audit, and opportune reports must be recorded with the SEC to keep up the public offering. When endorsed by the SEC, orders for offers might be requested from people in general by going with sales materials and disclosures, such as a prospectus.
Penny Stocks Trading
After introductory requests are gathered and the stock is sold to investors, an enlisted offering can start trading the optional market through posting on the NYSE and NASDAQ or trading over-the-counter. Numerous penny stocks end up trading by means of OTC because of the strict requirements for listing on the bigger exchanges.
Some make an extra auxiliary market offering after the IPO, which weakens the current offers yet gives the company access to more investors and expanded capital. Besides, it is obligatory that the company keeps on giving updated financial statements to keep investors informed. It should also keep up the capacity for quoting on the Over-the-Counter Bulletin Board.
Penny Stocks SEC Rules
Penny stocks are viewed as profoundly theoretical investments. To secure the investor’s interest, the SEC and the Financial Industry Regulatory Authority (FINRA) have explicit principles to regulate the sale of penny stocks. Every single broker-dealer needs to comply with the requirements of Section 15(h) of the Securities Exchange Act of 1934. It should follow rules to be qualified to deal with any transactions in penny stocks.
- Adhering to the standards of SEC §240.15g-9, the broker-dealer must support the investor's transaction and ensure the investment is appropriate for their purchase.
- They should give a standardized disclosure document to the client as delineated in §240.15g-2. This document contains a clarification of the risk related with purchasing penny stocks, client rights, and remedies in cases of fraud.
- Broker-dealers must follow §240.15g-3 and disclose and affirm the currently quoted cost estimates before finishing the transaction.
- SEC principle §240.15g-4 expresses the broker must inform the investor concerning the assets they acquire by facilitating the transaction.
- Brokers must send month to month statements that incorporate insights concerning the number and personality of every penny stock in the client's record as depicted by rule §240.15g-6. These Broker-dealer statements must clarify that the penny stock has constrained market liquidity and give an estimate of what they think the offers are worth in this restricted market.
After-Hours Trading
Penny stocks can be traded after hours, and since numerous significant market developments can occur after trades close, penny stocks are dependent on volatile fluctuations after hours. If penny stock financial investors purchase or sell trades after hours, they may be ready to sell shares at significant expenses or buy shares at low costs.
In any case, even the best penny stocks are liable to low liquidity and second rate detailing. Additionally, if a penny stock does spike after hours, an investor hoping to sell the stock may make some hard time finding a purchaser. Penny stocks rarely trade, much more so after market hours, which can make it hard to purchase and sell after hours.
When Is It Not a Penny Stock?
Various events can trigger the change of a penny stock to a customary stock. The company can give new securities in an offering that is enlisted with the SEC, or it can enroll a current class of securities with the administrative body. The two sorts of transactions automatically require the firm to adhere to periodic reporting, including disclosures to investors about its business exercises, money-related conditions, and company management unless there is an exemption. These filings likewise command 10-Q quarterly reports, the yearly Form 10-K, and periodic Form 8-K reports, which detail unexpected and significant events.
In certain instances, there are extra conditions that will require a company to record reports with the SEC. Reports must be filed if a company has either at least 2,000 investors or in excess of 500 investors that can't be classified as certified investors, and who have more than US$10 million in resources. For the most part, companies without any $10 million in resources and less than 2,000 recorded shareholders don't need to hold fast to revealing rules under the SEC. Strikingly enough, a few companies select transparency by documenting similar kinds of reports that other firms are required to do.
If a business lists its securities on any national security exchange, such as NYSE or the NASDAQ, it must file too. In conclusion, SEC enrollment is compulsory if a company's securities are quoted on the OTCBB or under the OTCQB cmarketplace of the OTC Link.
Penny Stock Example
Most penny stocks don't trade on the major market exchanges. However, there are some large companies, in view of market capitalization, that trade below $5 per share on the main exchanges like the NASDAQ.
A case of a penny stock recorded on the NASDAQ is Curis Inc. (CRIS), a small biotechnology organization.
- On the day of March 13, 2019, CRIS closed at $1.29.
- CRIS posted a $1.47 closing price by the end of the next day, March 14, 2019.
- The stock price for CRIS gained approximately 14% in one day.
- CRIS traded at $1.15 at the close of the day March 5, 2019, a week earlier.
- The stock closed at $1.06 for March 8, 2019 three days later. The loss in value was 8.5% for the three days.
In spite of the fact that there can be sizable increases in trading penny stocks, there are additional risks of losing a lot of investment in a short period of time.
KEY Notes
- Penny stock refers to a small company's stock that typically trades for less than $5 per share.
- Even though some penny stocks trade on large exchanges such as the NYSE, most penny stocks trade via over the counter through the OTC Bulletin Board (OTCBB).
- While there can be sizable gains in trading penny stocks, there are also equal risks of losing a significant amount of an investment in a short period.