A penny stock is a stock from a company with a 'market capitalization' or market cap, of less than $1 billion. A company's market cap is a measure of its total market value. It is determined simply by multiplying the price of a share of stock by the total number of shares out in the market ('outstanding shares').

Since it is based off of market price, it is not a true company valuation like an 'audit' would provide. It is determined by the market as a whole, and can be swayed by any number of different variables.

Most often, this relatively low market cap that penny stocks have is due to a low price per share (PPS for short). The price of a small-cap stock can have a wide range, therefore, depending on the outstanding shares. However, most small-caps have prices that can be measured in pennies, hence the name 'Penny Stock'.

There are even 'Sub-Penny' stocks, that trade as low as .0001 dollars. Such stocks are often referred to as 'Micro-Cap' or 'Nano-Cap', with market caps of less than 250 and 50 million dollars respectively. These terms are typically used very loosely, however.

Why should I trade penny stocks?

Trading penny stocks, while inherently risky, has some unique benefits. Penny stocks are the fast movers of the stock market. While large stocks such as IBM and Microsoft lumber along like the giants that they are, penny stocks often race around like Ferraris. Think of it this way, for you to double your money in a $30 stock, it must go all the way to $60. To double that same money in a stock that is $.01, it must only gain one cent to get to $.02...

Now, let's think of this in terms of 'market cap', the market valuation of the company. For comparisons sake, lets say both stocks have 100 million outstanding shares. If the $30 company doubles, its market value rises by 3 billion dollars! For the $.01 company to double, its market value must only rise by $100,000. Essentially, the expensive stock requires much much more money input, or buying, for the price to move. This is why penny stocks can move so quickly, and make you a profit in very little time.

What else makes penny stock investment different?

One of the major differences between trading a penny stock and a 'blue chip', for example, is the amount of - and ability to find - information on them. For the most part, penny stocks trade on either the 'OTCBB' exchange (over the counter bulletin board) or on what is called the 'Pink Sheets'. Pink sheet stocks have no reporting requirements, and are often a small company's first attempt at being publicly owned. OTC stocks do have requirements, but they are not as intense as stocks listed on major exchanges. With less information available, penny stocks easily become valued based on pure market speculation and can be easily influenced by internal and external forces. For example: The company itself could be a complete scam. The stock could be under promotion by a paid service in an effort to increase investor interest. Groups of traders could be working together to convince others to buy, while they sell into the resulting rise. The 'Market Makers' (professionals that act as buyers and sellers to maintain an orderly market) can also easily manipulate the price of a stock to a fairly drastic degree.

So, while penny stocks do offer the potential to rise 100%, 200%, or even 1000% in a short period of time, they also carry with them some big risk factors. To be successful trading them, you must find the stocks that have the best potential, fewest number of "red flags", and have a strategy that will let you lock in solid profits and reduce risk.

BlueWaterArticles.com: - What is a Penny Stock

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