What Price Is Considered a Penny Stock? The Complete Guide for Investors

Are you looking to dip your toes into the exciting world of penny stocks but not quite sure what actually counts as one? You’re not alone! One of the most confusing aspects for new investors is understanding exactly what price defines a penny stock Let me break it down for ya in simple terms so you can decide if these low-priced securities deserve a spot in your investment portfolio

The Official Definition: It’s Not Actually a Penny!

Despite what the name suggests, penny stocks don’t actually cost just a penny. According to the U.S. Securities and Exchange Commission (SEC), penny stocks are securities that trade for less than $5 per share. This might be surprising to some folks who thought these investments literally cost pennies!

The SEC uses this $5 threshold as their official classification but in practice you’ll find different definitions depending on who you ask

• SEC Definition: Any stock trading under $5 per share
• Traditional Definition: Stocks trading for less than $1 per share
• Some Brokers: Stocks trading on OTC (Over-The-Counter) markets, regardless of price
• Fidelity: Often refers to them as “micro-cap stocks” or “small companies”

Historical Context: From Pennies on the Dollar to Five Bucks

The term “penny stock” has an interesting history. It originally referred to shares that traded for “pennies on the dollar” back in the day. When the U.S. government passed the Securities Exchange Act in 1934, the SEC established that equity securities trading for less than $5 per share couldn’t be listed on any national stock exchange or index.

While the name stuck, the actual pricing threshold has evolved over time. It’s worth noting that in countries outside the U.S., the same $5 equivalent doesn’t necessarily apply, since stock prices are denoted in local currencies. For example, in China, it’s pretty common for even large company IPOs to have prices between 10-40 Rmb per share (about $1.50-5.50 in US dollars).

Where Can You Find Penny Stocks?

Penny stocks can be found in several places:

• OTC Markets: Many penny stocks trade on Over-The-Counter exchanges like OTC Link LLC (previously known as Pink OTC Markets)
• Former OTCBB: The OTC Bulletin Board used to be a common place for penny stocks
• Major Exchanges: Some penny stocks do trade on major exchanges like Nasdaq or NYSE, but these exchanges require listed companies to maintain a minimum share price of $1.00
• Foreign Exchanges: Penny stocks can also be found on securities exchanges in other countries

When a company’s stock falls below $1 on major exchanges like Nasdaq or NYSE, they risk being delisted. To avoid this, many companies perform a reverse stock split to artificially boost their share price while keeping the company’s overall value the same.

Why Do Some Investors Love Penny Stocks?

I’ve talked to lots of penny stock enthusiasts, and they usually point to a few main attractions:

1. Low entry price: You can buy thousands of shares for a relatively small investment
2. Perceived upside potential: The possibility of significant percentage gains if the stock rises even by small amounts
3. The “ground floor” appeal: The idea of getting in early before a company potentially makes it big
4. Quick movement: Penny stocks can make dramatic price moves in short time periods

As one investor told me, “I bought 50,000 shares at 8 cents each, and when it hit just 16 cents, I doubled my money!” Stories like this create a powerful allure, but they don’t tell the full story.

The REAL Risks of Penny Stocks You Need to Know

Before you rush off to invest your hard-earned cash, let me give you the straight talk about the serious risks involved:

1. Lack of Transparency

One of the biggest problems with penny stocks is the limited information available. Unlike companies listed on major exchanges, penny stocks generally:

• Aren’t required to provide the same level of financial disclosure
• Often have little to no analyst coverage
• May have limited public information available for research

This lack of transparency makes it extremely difficult to properly evaluate these companies.

2. The Infamous “Pump and Dump” Schemes

Unfortunately, penny stocks are notorious for being vulnerable to manipulation schemes. Here’s how a typical “pump and dump” works:

• Scammers acquire large positions in a penny stock
• They promote the stock aggressively through newsletters, online forums, social media, or email blasts
• They make exaggerated claims about the company’s potential
• Once enough investors buy in (pumping the price up), the scammers sell their shares (dumping)
• The stock price collapses, leaving ordinary investors with big losses

The FBI and prosecutors regularly report that fraud is widespread in the penny stock market, with some schemes resulting in tens of millions in losses.

3. Liquidity Problems

Many penny stocks have very low trading volume, which creates serious problems:

• Difficulty buying or selling shares when you want to
• Wide bid-ask spreads (the difference between what buyers are willing to pay and what sellers are asking)
• Higher transaction costs relative to mainstream stocks
• Potential for sharp price drops when trying to sell

4. Extreme Volatility

The small size of these companies means their stock prices can swing wildly:

• Rapid price changes in either direction
• Higher potential for complete loss of investment
• Greater uncertainty about fair value

Real-World Examples: The Dark Side of Penny Stocks

Let me share a few historical examples that highlight the dangers:

The Zirk de Maison Case: Between 2008 and 2013, de Maison created five shell companies that had no actual business or legitimate assets. He offered shares to the public, used fake names to convince investors to buy, drove up prices artificially, and then dumped his shares – leaving investors with nearly worthless stock.

The Mafia Connection: By the 1970s, organized crime had infiltrated Wall Street, particularly in the penny stock market. In the 1980s, Lorenzo Formato conducted penny stock manipulations and later testified about rampant penny stock manipulation by organized crime. This led to the Penny Stock Reform Act of 1990.

Major Brokerages: In the 1980s and 1990s, several penny stock brokerages became infamous, including Blinder Robinson (nicknamed “Blind’em and Rob’em”), First Jersey Securities, Rooney Pace, Stuart-James, and Stratton Oakmont (featured in the movie “The Wolf of Wall Street”).

How Are Penny Stocks Regulated?

Due to the high risk of fraud, penny stocks are subject to specific regulations:

• The SEC has rules that define and regulate penny stock sales
• FINRA (Financial Industry Regulatory Authority) has additional requirements
• The State of Georgia was the first to create comprehensive penny stock securities laws, which became a template for other states
• Brokers must provide special disclosure documents before selling penny stocks to customers

Should You Invest in Penny Stocks?

Look, I’m not here to tell you what to do with your money, but here’s my honest take based on the facts:

Penny stocks carry significantly more risk compared to established companies. While there is potential to make money, there’s an even stronger chance of losing part or all of your investment.

If you’re still interested despite the risks, here’s what you should do:

1. Research extensively: Do as much due diligence as possible on any company
2. Verify information: Don’t trust promotional materials or tips without verification
3. Consider your financial goals: Make sure penny stocks align with your investment objectives and risk tolerance
4. Limit your exposure: Only invest what you can afford to lose completely
5. Be skeptical: If something sounds too good to be true, it probably is

Most brokerages, including Fidelity, require customers to acknowledge their understanding of the specific risks associated with penny stocks before allowing them to trade these securities.

Alternative Investment Options

If you’re attracted to penny stocks because of their perceived growth potential but concerned about the risks, consider these alternatives:

• Small-cap ETFs: These offer exposure to smaller companies with greater diversification
• Established growth stocks: Companies with proven business models but still significant growth potential
• Fractional shares: Many brokerages now let you buy portions of higher-priced quality stocks

The Bottom Line on Penny Stock Pricing

To wrap things up and answer the original question directly:

• According to the SEC: A penny stock is any stock that trades for less than $5 per share
• In common usage: Many investors consider only stocks trading under $1 to be true penny stocks
• For regulatory purposes: The $5 threshold is what matters for disclosure requirements and other rules

Remember, the price alone doesn’t tell the whole story. Market capitalization, company fundamentals, trading volume, exchange listing, and regulatory compliance are all critical factors to consider before investing.

A penny stock is a share of a company that trades for less than $5 per share and typically has a low market capitalization.