Ask any investor what a stock trading under $5 is and they will tell you it is a penny stock, microcap stock, or nano stock.
These three terms are for the most part interchangeable. However the broader definition of a penny stock refers to a business’s aggregate value of its outstanding common shares, are more commonly known as its market capitalization rather than its stock price. However there is no set term that completely defines a penny stock.
To calculate the market capitalization of a company (the market cap) you must multiply the stock price of the company by the amount of shares that are outstanding. By carrying out this calculation you can find out what the total dollar value of all shares in the company are at any given moment in time.
Penny stocks are not traded on a stock exchange like other stocks but they are traded in the over-the-counter (OTC) market. For the trading of most stock an agent will act on the investors behalf and arrange a transaction directly between the investor and a third party. The broker then receives a commission for facilitating the trade.
A large proportion of all penny transactions are charged by brokers as principle transactions.
This means that the broker is not paid any commission but rather makes its money on the spread, and by buying and selling at advantageous times. There is no single price at which penny stocks are bought and sold, but rather there are a number of different prices.
The difference between the bid and ask price is known as the spread. The spread of many penny stocks are usually around 25-33% but can often be 50-100% or even more. There are also always two bid and two ask prices, these are known as the inside and outside bid and ask. Keep in mind that it is the outside bid and ask that is of most interest generally.
Penny stocks are also subject to mark up pricing. This is where a broker has held the penny stock in its account and has therefore taken some of the risk associated with market price fluctuation.
Although penny stocks are quite complicated and there are many problems associated with trading penny stocks as well as millions of dollars of loss, many companies still trade in them because they can help for example, struggling companies just starting up. The best way of finding a good investment is by consulting with your broker. However in the penny stock market be very wary of brokers who are only trying to sell and may not have your best interests in mind.