It’s every investor’s dream: to buy penny stocks which eventually grow to become, well, worth a whole hell of a lot more. But buying penny stock is also well-known to be fraught with danger, at least to the uneducated buyer.
Definition of a true penny stock
Don’t listen to anyone who tells you that a penny stock is any stock trading below $1 (or, for pennies). This is absolutely not true, and by this definition Citibank would’ve qualified as a penny stock as recently as last week when it dipped below a dollar. And Citi is definitely not a penny stock.
You need to look at the market capitalization of the company as a whole before you buy stocks, not just the price for one share, which is really almost totally irrelevant to anything. A true penny stock is traded over-the-counter (OTC) as opposed to being listed on any major exchange. Its company will currently not be worth all that much; maybe $30 million, maybe less. But the fact that it trades over-the-counter is really the single best definition of a real penny stock.
How to buy penny stocks
The fact that the stock trades OTC makes it quite a bit tougher to buy penny stocks. And more expensive! You will have to pay anywhere from 25% to over 100% over the quoted price of your penny stock, which means that if you want to buy one share of a penny stock worth $0.50, you could pay anywhere from $0.63 to over $1 for that share.
Many online brokers won’t buy penny stocks for you, and you may have to go through an actual “real-life” broker who deals in OTC stock or do further research into access to the OTC bulletin board (OTCBB) where many of these stocks trade.
A word of caution before you buy penny stocks
Because penny stocks trading on the OTCBB do not have to meet the same rigorous requirements that companies trading on major exchanges do, it can be very risky to buy penny stocks if you don’t really know what you’re doing and who you’re doing it with.
These companies don’t have to meet minimum standards in order to remain trading and there is a lot of “backroom” manipulation of penny stock. Don’t get taken for a ride. Always do your due diligence and then do it again before you buy stocks, wherever they trade over-the-counter or on the NYSE.
The lack of liquidity that obviously exists in the OTC market is an obvious downside, all other things equal. You don’t have to be that big of an investor to drive the price of your own stock down by selling! That’s not the kind of power we really want, is it?
Also, watch out for new listings or startups. There exists a lot of irrational hype for penny stocks out there which can be magnified when you can’t even access the company’s past performance because it doesn’t exist.
All this said, it’s a verifiable fact that some stocks do rise from the penny stock level into what I would call micro-caps, on into mid-caps and even large-caps. You can buy stocks of any size and make a profit. Maybe you have investing in your blood. Maybe you're a natural-born stock picker. Maybe you are the next Buffett ;-) Someone's got to be. I don’t mean to put out your (or my) dreams to buy penny stock that soars; I wish us well.