Although there is not necessarily any one dictionary definition for a penny stock they are generally thought to be any stock that is price at less than $5 per share. Now depending on who you talk to you may get a slightly different opinion as to what the definition of a penny stock is. Some define them as stocks that trade on the Pink Sheets or the Over-The-Counter Bulletin Board (OTCBB). Most of these people still will include the price component of less than $5 per share. There are a few out there that have labeled only stocks that trade at a value of less than $1 as penny stocks. This would be a very restrictive definition. There are also those out there that assumed that a penny stock was anything that traded at a penny or less per share. Those stocks are considered sub-penny stocks and as a general rule you should stay as far away from them as possible. There are even a few who define a penny stock by the market capitalization that they possess. However, the term micro-cap would better suit these type of companies. Admittedly, penny stocks are micro-caps but the definition of penny stocks should revolve around the share price of the company as opposed to its market cap.
Some have assumed that any company that is labeled a penny stock is a company with shady accounting practices and without a strong business model. Actually, that would be incorrect. While it is true that this might be able to be said about some penny stock companies, it is also true that many of the companies that fall into the penny stock category are very well known companies with a strong brand name. Recent examples of companies that have fallen into the land of penny stocks over the last four or five years would be Citigroup (C ), American International Group (AIG), Ford Motor Company (F), Etrade (ETFC), General Motors (GM) and others like them. Even the company that many had considered to be the greatest company that has ever existed (General Electric) came within about $4 per share of getting into what is considered penny stock territory. Dell Computer (DELL) has done the same thing in the past.
So as you can see penny stock encompass a large range of stocks. They include well known companies that have fallen on hard times due to a misstep by those leading the company or due to a poor economy and they included companies who would be considered far from reputable. However, most of the companies that would be categorized as penny stocks are simply companies struggling to make a go of it in their particular industry. They may be a biotech company that is using or has used most of its available cash in research and development for the line of drugs that it is pursuing. It may be a company that is trying to make a go of it in an area such as alternative energy, such as wind energy or solar energy. A penny stock can be an up and coming company on the cutting edge of technology that is trying to make a name for itself and that is tying to carve out a niche in a competitive industry. Don't make the assumption that all penny stocks are companies without a solid business model that teter on the brink of bankruptcy. Nothing could be further from the truth.
Penny stocks can provide the investor with potentially large returns on the capital invested in them. The reason that this is the case is that they often provide explosive movement whenever there is positive news on the companies. Of course, they can also be explosive in the wrong direction as well. That is why it is best to trade penny stocks with a particular strategy in mind. One of the most effective strategies would be to trade penny stock breakouts. Companies that break out of a trading range have a tendency to continue to move in the same direction for a while.
It is definitely true that penny stocks carry a risk that is greater than investing in blue chip stocks, however, they also present the trader with a higher potential reward as well. If you are going to invest in penny stocks make sure that you take trades that present a higher reward than risk and make sure that you place at least a mental stop on the stock in case it begins to move against you.