Penny Stocks
Penny stocks are shares of very small companies that trade at low prices, often on over-the-counter markets. They are cheap per share but thinly traded, poorly researched and a frequent target for manipulation, so they carry very high risk.
Buying thousands of shares for a few hundred dollars feels like a lottery ticket: if the price goes from $0.20 to $2, you make ten times your money. That appeal is exactly why penny stocks are risky. They are tiny companies with little public information, wide spreads and few buyers — and a favourite tool of fraudsters. This entry explains what penny stocks are, why they move so much and what to watch for.
- Category
- Trading Basics
- Reading time
- 4 min
- Also called
- Penny stock, Microcap stocks, Nanocap stocks
- Updated
Penny stocks in plain words
"Microcap stock", sometimes called penny stock, refers to companies with low or micro market capitalisations.1
Companies worth less than about $250–300 million are often called microcaps, and those under $50 million are sometimes called nanocaps.1
Fraudsters have long targeted low-priced microcap stocks trading over the counter.2
How penny stocks trade, step by step
Find the listing
Often over-the-counter rather than a major exchange. See Over-the-Counter Market.
Check the spread
Bid and ask can be far apart. See Bid-Ask Spread.
Check volume
Few shares may trade each day. See Liquidity.
Look for filings
Many have little reliable public information.
Size small
Assume you could lose the whole stake. See Position Sizing.
Plan the exit
Selling can be harder than buying.
Worked examples
Example 1 — The spread cost
−18% on entryBid $0.18, ask $0.22. You buy 10,000 shares and immediately sell.
| Buy at ask | 10,000 × $0.22 = $2,200 |
| Sell at bid | 10,000 × $0.18 = $1,800 |
| Instant loss | −$400 (−18%) |
Wide spreads in thinly traded stocks mean you start well behind. See Bid-Ask Spread.
Example 2 — A big percentage move
+50%You buy 5,000 shares at $0.40. A week later the price is $0.60.
| Cost | 5,000 × $0.40 = $2,000 |
| Value | 5,000 × $0.60 = $3,000 |
| Gain | +$1,000 (+50%) |
Small companies can move by large percentages quickly — in both directions.
Example 3 — Market cap, not share price
Cheap ≠ smallCompany A: $0.50 a share, 2 billion shares. Company B: $80 a share, 10 million shares.
| A market cap | $0.50 × 2bn = $1bn |
| B market cap | $80 × 10m = $800m |
Microcap is defined by market capitalisation, not by a low share price.1 See Market Capitalisation.
Penny stocks vs large-cap stocks
| Aspect | Penny stocks | Large caps |
|---|---|---|
| Company size | Micro or nano | Billions |
| Liquidity | Thin | Deep |
| Public information | Often limited | Extensive |
| Manipulation risk | High | Low |
Why traders look at penny stocks
Speculation
Chasing large percentage moves. See Speculation.
Early-stage bets
Small companies that might grow.
Momentum trading
Riding sudden volume spikes. See Momentum Trading.
Learning what to avoid
Recognising promotion schemes. See Pump and Dump.
Advantages and disadvantages
Advantages
- Low cost per share.
- Potential for large percentage gains.
- Access to very early-stage companies.
Disadvantages
- Thin trading and wide spreads.
- Little reliable information.
- Frequent targets of fraud.
- High risk of losing everything.
Going deeper
Read as far as you need. Each level builds on the one before it.
Low price is not a bargain
Beginner
A $0.10 share is not cheap if the company is worth nothing. What matters is the business and its valuation. See Market Capitalisation.
Hype and social media
Intermediate
Heavily promoted small-cap stocks are often discussed in social media, newsletters and chat rooms, and short-term trading based on that hype carries significant risk.3
Why fraudsters like them
Advanced
Owning a large portion of a small company's shares makes it easier to push the price artificially higher before selling.2 See Pump and Dump.
Common mistakes
Judging by share price
Market cap, not price, shows size.
Trusting promotions
Unsolicited tips are a major red flag.
Ignoring liquidity
You may not find a buyer when you need one.
Oversizing
Treat the whole stake as at risk.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Penny stocks are shares of very small companies.
- Microcaps are usually under about $250–300 million.
- They are thinly traded with wide spreads.
- They are common targets of pump-and-dump fraud.
- Size positions as if you could lose it all.
Frequently asked questions
Are penny stocks a good way to start investing?
Do penny stocks trade on major exchanges?
Can a penny stock become a big company?
Further learning
- Pump and Dump
The scam that targets them.
- Market Capitalisation
How company size is measured.
- Liquidity
Why thin markets are risky.
- Bid-Ask Spread
The hidden cost of trading them.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Investor.gov (SEC). Microcap stock (glossary) (opens in a new tab) Checked .
- FINRA. Avoiding Pump-and-Dump Scams (opens in a new tab) Checked .
- Investor.gov (SEC). Investor Alert: Thinking About Investing in the Latest Hot Stock? Understand the Significant Risks of Short-Term Trading Based on Social Media (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.