How to Invest in Penny Stocks

Posted at February 7, 2010

Investors consider any stock selling for less than $5 a penny, microcap or nano stock. For all practical purposes, these three designations are synonymous. A more inclusive description of a penny stock makes reference to a company's total worth of its outstanding common stock, also referred to as its market capitalization, instead of the price of its stock. In reality, there is no single term which fully characterizes a penny stock.

The market capitalization of a business, otherwise known as the market cap, is equal to the company's current stock price multiplied by the number of shares of stock outstanding. The performance of this simple exercise in mathematics will result in the total dollar value of all of a company's shares at a precise point in time. Penny stocks, unlike most stocks, trade in the over-the-counter (OTC) market as opposed to being listed on one of the stock exchanges. In the case of most stock transactions, an investor will employ an agent to act on his behalf to set up a transaction with a third party. This broker, as the agent is routinely called, will then earn a commission for expediting the transaction.

Brokers tend to charge most penny transactions as principle transactions. This way the broker is not earning money through commissions but rather on the spread through buying an selling at key moments. The prices at which penny stocks are both bought and sold will vary. The gap between the asking price and the bid that is made is what is known as the spread.

Penny stocks have a typical spread of between 25% and 33%, however they can get as high as between 50% and 100%, or higher. In addition, two bid and two ask prices are constantly present. These are known as the inside bids and asks, and the outside bids and asks. Remember that the outside bid and the outside ask are the aspects that generate the most action. Moreover, the prices of penny stocks can be marked up. This means that an agent has kept a penny stock aside, and, as a result, has assumed a portion of the risk that comes with the changes in market price.

The process of buying penny stocks can be somewhat complicated and problems can sometimes arise, millions are also sometimes at risk, however they can be helpful to new companies that are struggling for capital. Discuss possible investments with your broken, this way you can be sure you're making good decisions. Just be aware that some brokers dealing in penny stocks may only be interested in selling and not the getting you the best investment.

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