To define penny stocks is easy, you can find the definition in any stock-related websites. But to understand penny stocks takes you time and effort. The following 6 basic terms will help you have an overall knowledge of this potential but risky instrument.

Liquidity:

Liquidity refers to the ease with which a stock can be bought or sold in the market without significantly impacting its price. Higher liquidity generally indicates a more active market for the stock.

Likewise, if there is a low level of liquidity, which is always the case in the penny stock market, it may be hard to find a buyer for a particular stock, and you may be required to lower your price until it is considered attractive to another buyer.

Market Capitalization:

Market capitalization is a measure that indicates the aggregate value of a company’s outstanding shares of stock. To calculate it, multiply the current share price by the total number of shares outstanding. Market capitalization helps determine the size of a company and its relative position in the market.

Unlike those biggest market cap companies, a business is placed into the “penny” category if its market cap is less than £100m.

Over-the-counter (OTC):

Penny stocks are commonly traded over-the-counter (OTC), which means they are not listed on major stock exchanges. Instead, they are traded through decentralized platforms, such as the OTC Bulletin Board (OTCBB) or the Pink Sheets, which have less stringent listing requirements.

Volatility:

Volatility refers to the price fluctuations of a stock over a given period.

Penny stocks normally have a higher volatility than blue-chip stocks. This high volatility implies larger and more frequent price swings, making penny stocks riskier but potentially offering greater opportunities for quick gains – or losses.

Volume:

Volume is the number of shares of a stock traded during a specific time period, typically measured on a daily basis. Higher trading volume indicates greater market activity and interest in the stock.

Penny stocks are investments with low trading volumes. Due to their low volume, penny stocks tend to exhibit higher volatility.

Diversification:

Diversification is the strategy of dispersing investments among various assets or securities to mitigate risk.

In the context of penny stocks, diversification allows you to decrease the effect of poor performance of a single stock on the overall portfolio.