Penny stock

Quick definition

A penny stock is a stock of a typically small company that trades for less than $5 per share.

Key details

• Penny stocks are defined by the US Securities and Exchange Commission (SEC) as all company shares that trade below $5 each
• A lack of liquidity is typical of small companies and this means that penny stocks are traded infrequently and have few ready buyers 
• Penny stocks are highly speculative investments intended for investors with large risk appetites

What is a penny stock?

A penny stock is any stock that sells for under $5 each. These are typically stocks in small companies that have low liquidity as they are in the growth stage seeking funds from the public on the stock market. As such, penny stocks trade infrequently and have a lack of ready buyers in the marketplace.

Only investors with high risk capacity should consider investing in penny stocks. Small companies suffer growth uncertainties and this makes penny stocks highly volatile, risky, and speculative investments. investors must do their own due diligence and invest with care as they risk losing their entire investment on a penny stock.

With high risk comes high reward and consequently, penny stocks can have explosive gains. You must always budget what you can afford to lose. It is imperative to set realistic expectations and understand that penny stocks are high-risk investments with low trading volume.

What are the defining characteristics of penny stocks?

1) They trade at pennies per share

This is the only hard and fast rule of penny stocks. While many different fundamental and technical parameters may apply, penny stocks by definition are those that trade at a price of less than $1 per share.

2) They often have spotty fundamentals

Stocks typically rise based largely on the strength of their earnings growth, or at the very least their potential earnings growth. Penny stocks usually trade at that low level in large part because they lack that kind of earnings power.

3) They lack institutional support

Big-money institutional investors such as mutual funds and hedge funds favour highly-liquid stocks that trade in hefty daily volume. Penny stocks lack that kind of volume and liquidity, so institutional investors tend to stay away.

4) They have unfavourable bid-ask spreads

When a stock trades at pennies per share, every cent matters. The problem is that penny stocks’ lack of liquidity also contributes to large spreads between bid and ask prices, which can make it difficult to get in at the purchase price that you want.

What are some examples of penny stocks?

(Warning: Penny stocks are far more volatile and far more speculative than other stock types. We are highlighting these four stocks, but also advising extreme caution, and reminding you that other stock types typically make for safer investments).

1) Sequential Brands Group (SQBG)

The parent company of lifestyle retail brands such as Jessica Simpson, And1, and Heelys saw its stock more than double on June 9, 2020. One day earlier, the stock soared 31% as more than 23 million shares changed hands.

2) Ideanomics (IDEX)

As of press time, Ideanomics’ stock was threatening to ditch its penny-stock status. The producer of group discounts on commercial electric vehicles and developer of financial technology products saw its stock rocket nearly 60% in early trading on June 9, 2020, nearing the $1 per share mark.

3) Exela Technologies (XELA)

Exela is a business process animation company with a market cap of about $100 million. The stock shot up 50% in early trading on June 9, 2020, trading around 65 cents a share by midday.

4) General Moly (GMO)

Founded in 1925, the Colorado-based mineral mining company saw its stock rise more than twofold from its late-March low of 14 cents to its June 9 close of 31 cents.

Where can I learn more?

To find out more about penny stocks and other key financial concepts, check out our full course page about stocks. Our courses shall guide you through everything you need to know about stocks and investing.