Penny stocks carry a specific SEC definition and specific regulatory guardrails — not just a colloquial term for "cheap stock."
The Definition and Guardrails
The SEC formally defines a penny stock as any equity priced below $5 per share. Because of the elevated fraud and volatility risk historically associated with this segment, federal rules require your broker to specifically approve your account for penny stock trading, make a suitability determination, and deliver a mandatory SEC risk disclosure document before the first trade. These regulatory requirements exist precisely because penny stocks have historically seen a disproportionate share of pump-and-dump schemes and companies at genuine risk of financial instability or bankruptcy.
A low share price alone tells you nothing about whether a company is a genuine bargain or approaching failure — always check the underlying reason the price is low (declining revenue, dilution from repeated share issuance, delisting risk) rather than assuming a low price implies unusual upside.
Someone Attracted to a Penny Stock's Low Share Price: Investigate the reason it's priced that low before assuming it's simply undiscovered.
Someone New to Penny Stock Trading: Expect your broker to require specific account approval and a mandatory risk disclosure — a genuine regulatory signal about the segment's risk.
Approach Penny Stocks the Way
- Investigate the cause of a low share price before buying.
- Expect elevated fraud risk in this segment specifically.
- Size any position small given the documented volatility and liquidity risk.
See small-cap stocks explained for a less extreme size-based risk category.
