Are Penny Stocks Still a Thing? Yes, Here’s How
Are penny stocks still relevant? Yes. This article explains their continued presence in today's financial markets and how they function.
Penny stocks remain a notable segment of financial markets. They offer opportunities outside of traditional exchanges. Understanding them involves recognizing their characteristics and trading mechanisms. This article explores the nature of penny stocks and their regulatory frameworks.
Defining Penny Stocks
In the United States, a penny stock is defined by the U.S. Securities and Exchange Commission (SEC) as a security issued by a small public company that trades at less than $5 per share. These companies generally have a low market capitalization, often less than $300 million, distinguishing them from larger, more established corporations. While the term “penny stock” historically implied shares trading for literal pennies, the definition has broadened to include stocks priced up to a few dollars.
Penny stocks are distinct from blue-chip stocks or those of well-known companies listed on major exchanges. They are not listed on national stock exchanges like the New York Stock Exchange (NYSE) or NASDAQ due to not meeting the listing requirements. Instead, they often represent smaller or developing companies that may have limited operating histories or financial data.
Trading Penny Stocks
Penny stocks are primarily traded on Over-The-Counter (OTC) markets, rather than centralized exchanges. These decentralized markets facilitate direct trading between parties, typically through a network of brokers and dealers. The OTC Markets Group operates the largest of these networks, providing quotation and information services for nearly 10,000 OTC securities.
OTC Markets Group organizes these securities into distinct tiers, which indicate varying levels of financial reporting and transparency. The OTCQX is the top tier, featuring companies with high financial standards and readily available information. The OTCQB is a middle tier for venture-stage companies that are current in their financial reporting, and the OTCPink (also known as Pink Sheets) is the most speculative tier with minimal disclosure requirements. Starting July 1, 2025, the OTCPink will transition to the OTCID Basic Market, which will establish minimal disclosure standards and require management certifications.
Buying and selling penny stocks involves using a brokerage account, though not all brokers offer access to all OTC markets. Brokerage fees can vary, with some charging flat fees per trade while others may charge per share, making it important to consider the cost structure. Electronic networks facilitate modern OTC trading, connecting buyers and sellers.
Market makers play a central role in these markets by continuously quoting both buy and sell prices, providing liquidity and facilitating transactions. They profit from the bid-ask spread, the difference between their bid and ask prices. For less liquid stocks like many penny stocks, this bid-ask spread can be wider, impacting the effective transaction cost for investors.
Regulatory Oversight
Penny stock trading operates within a regulatory framework for oversight and investor protection. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) oversee the markets where penny stocks trade. These organizations implement rules to govern trading practices and company disclosures, even for securities not listed on major exchanges.
Companies whose shares trade as penny stocks are subject to various disclosure requirements, particularly if they are SEC-reporting companies or trade on higher OTC tiers. The Securities Act of 1933 and the Securities Exchange Act of 1934 established foundational regulations for securities, including anti-fraud provisions that apply to penny stocks. Broker-dealers are also required to provide specific disclosures to customers before penny stock transactions, including a risk disclosure document and information about market quotations and compensation received.
Despite the lower listing standards compared to major exchanges, companies in the OTC market are still subject to these anti-fraud rules. Regulations aim to mitigate risks such as market manipulation, including “pump and dump” schemes where stock prices are artificially inflated. This regulatory environment, distinct from major exchanges, supports the legitimate, higher-risk presence of penny stocks.