We often get questions regarding penny stocks and over-the-counter trading because so many marijuana-related stocks are classified as such. In many cases, investors haven’t been able to ignore all the talk about gains in the cannabis sector and are now looking to arm themselves with knowledge before diving into this group of lesser-covered stocks.
What Are Penny Stocks?
Don’t let the name penny stock fool you, because it does not just apply to stocks that cost you 1 cent per share. As far as the regulators are concerned, the SEC considers a penny stock to be any small companies’ stock trading under $5 per share. These low price-per-share, low market capitalization companies are what are collectively referred to on Wall Street as penny stocks.
Although companies like mega-brewer Ambev SA (NYSE:ABEV) trade for under $5 per share, this $75 billion NYSE-listed company is not what most investors have in mind when they hear penny stocks. Traditionally, most penny stocks are traded over-the-counter (OTC) rather than on these national exchanges.
When people hear over-the-counter stocks, they think of scenes from The Wolf of Wall Street movie where brokers sell good-for-nothing corporate shells to unknowing retirement investors. Despite the pitfalls of penny stocks, many traders take a liking to the fact that penny stocks are small, lesser-known companies.
With oftentimes choppy trading and spotty volume, penny stocks can lead to both fortune and financial peril. While the ups and downs of penny stock price volatility can be really tough to stomach, they also possess hugely profitable trading opportunities not frequently found elsewhere.
Just because you don't find hear Warren Buffet out on Bloomberg TV recommending penny stocks doesn't imply that penny stocks are worth ignoring. Not shockingly, given this lack of widespread attention to these companies, many penny stocks in the past have earned notoriety for being diversions loaded with tricks and lies.
If you haven’t figured by now, penny stocks are extremely interesting, and worthy of further considerations. Shying away from risk also can mean shying away from reward. Without a doubt, investing in penny stocks could yield some of the craziest (good and bad) trades ever.
So if the majority of these companies are not listed on the NYSE or NASDAQ exchanges, how can investors trade penny stocks?
Trading Penny Stocks
Just like whichever other stocks you usually trade or invest in, you can buy most penny stocks through your usual broker-dealer. Same as in the supermarket with food goes in the supermarket of financial instruments…Just because they sell it doesn’t mean you should buy it, at least not without doing your due diligence.
As we mentioned before, the lower priced stocks listed on the NYSE and NASDAQ exchanges aren't regularly classified on Wall Street as penny stocks. With that being said, these low price shares can yield many of the advantages of smaller company penny stocks with a lot less risk.
Since the NYSE and NASDAQ have stringent listing requirements with regard to company size and more, it takes a lot of the potential gains off the table that are present in the small and micro-cap penny stocks.
Keep in mind that the listing requirements also take a lot of the guess work out of what is going on with the business, and therefore the companies have a tendency to be more solid overall than those listed OTC.
Trading OTC Stocks
As for over-the-counter stock trading, there are a few notable distinctions to be made between the different listing services (similar to exchanges).
When looking for penny stock listings, there is the FINRA-operated OTC Bulletin Board (OTCBB), as well as three more that are owned and operated by OTC Markets Group Inc.
The OTC Bulletin Board (OTCBB) is a quoting system operated by the Financial Industry Regulatory Authority (FINRA) to provide FINRA broker-dealer members with market quotes as well as a system to post their own market making bids, offers, and indications of interest to other broker-dealers. OTCBB eligibility is determined by FINRA Rule 6530, and is far easier to satisfy these listing requirements compared to the requirements of the NYSE or NASDAQ exchanges.
Whereas OTCBB is merely a broker-to-broker quoting service, the OTC Markets Group offers an Alternative Trading System (ATS) called OTC Link on which investors and traders can transact in these stocks based on transparent quotes and data. Since OTC Markets Group offers three distinct tiered marketplaces dependent “on the quality and quantity of information the companies make available,” almost any company can qualify to list on one of these markets.
The three tiers that OTC Markets Group has in order of listing requirements from highest to lowest are:
We hope this has been a useful starter guide for anyone who was curious about penny stock investing or trading. We have gotten so many questions on the topic given that so many pot stocks are traded over-the-counter. With so many marijuana-related companies priced below $5 per share, we feel that it is important that our readers acquire all of the necessary foundational penny stock knowledge before trading these oftentimes-volatile securities.