What is Penny stock?
In short
A very cheap stock (under $5 by the SEC's definition), usually a small, illiquid company. Prone to manipulation.
A penny stock is a very cheap stock: by the SEC's definition, one trading under $5. These are usually small, often loss-making companies, and some trade not on major exchanges but over the counter (OTC), where reporting requirements are lighter.
Main risks
- Low liquidity. Daily volume is small, and a large order moves the price by itself.
- Wide spread. The bid-ask gap can be several percent of the price — just getting in and out is expensive.
- Little information. Few filings, no analyst coverage.
- Manipulation. Penny stocks are the main target of pump and dump schemes.
- Dilution. Cash-hungry companies often issue new shares, shrinking existing holders' stakes.
"Low price means big upside" is a fallacy: a $0.50 stock is not cheaper than a $500 one, it just has more shares. A company's value is measured by its market cap. Daily moves of 50–100% look like big profit potential but can wipe you out just as fast.
Organisers buy quietly near $0.50, hype lifts the price to $1.38 (+176%), and they sell at the top. Price collapses to $0.35 — someone who bought at $1.20 loses 71%.
Example
Illustrative: the stock trades at $0.40 with daily volume of 200,000 shares (about $80,000 in total).
- Bid $0.38, ask $0.42 → spread $0.04, or 10% of the mid price.
- You buy 10,000 shares at the ask: 10,000 × $0.42 = $4,200.
- If you sell straight away at the bid: 10,000 × $0.38 = $3,800.
- Even with no price change, the spread alone costs −$400, or −9.5%.
On top of that, your 10,000 shares are 5% of daily volume — your order itself may push the bid lower.
Mistakes and tips
Use only limit orders on penny stocks: a market order may fill at an unexpected price.
Ignore 'next 10x' posts on social media — that is a classic pump sign.
Keep position size small: spreads and gaps mean a stop can fill far worse than planned.
Try it first in paper trading to see how spread and liquidity affect results.
Frequently asked questions
- Can you get rich with penny stocks?
- Isolated cases exist, but most investors lose: spreads, thin liquidity and manipulation stack the odds against you.
- What price counts as a penny stock?
- By the SEC's definition, any stock under $5. In everyday use people often mean stocks under $1.
- Do cheap stocks rise more?
- No. Price depends only on the number of shares; upside is determined by the business, not by a low share price.
Learn it in the Academy
This term is covered with hands-on examples and a quiz in these lessons of the interactive course.
- What a stock is and why its price movesA stock is a real slice of a business. IPOs, market cap, how price forms, where returns come from, and the risks.Open lesson · 11 min
- Avoiding scams and CFDsCFDs and leverage in numbers, pump-and-dumps, Telegram "signal" scams, fake brokers, guaranteed-return schemes and how to verify a broker.Open lesson · 13 min
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