Penny stocks, micro-caps or nano-caps are terms for stocks with a share price of $5 or lower and a very small market capitalization. Small caps are usually not listed on the major stock exchanges like the Wall Street (NYSE) or the NASDAQ but traded on the OTC Bulletin Board (OTCBB) or on the Pink Sheets.

Penny stock trading includes high risks but also offers high profit potential. Penny stocks can move several hundred percent within days which is one of the major reasons why people consider penny stocks. Another reason is that an investor is able to acquire a significant stake of a company with relatively limited capital. It would be impossible to become a major Microsoft shareholder without spending millions but with penny stocks you can do this with a few thousands.

There are several disadvantages of penny stocks which makes them only suitable for experienced investors. Fist of all there is a big limitation in available information. Since the companies don't have to file any reports it might be difficult to find reliable information about the company and its financial situation. Only companies with assets of $10 million or more have to file a financial report with the SEC but the SEC can't verify the informations provided.

The other disadvantage is the lack of public interest. Together with the small number of shareholders the market for a small cap is usually very small. This means that trading volume is low and widely open to manipulation. It's difficult to buy and sell stocks of this company. It even might be impossible to sell the stock for weeks.

The low trading volume makes the stock vulnerable to big price fluctuations, also called volatility. While higher volatility means higher risks, it seems that there lies the only big advantage of penny stocks. While it is almost impossible for a big listed stock like Microsoft or IBM to move hundreds or even thousands of percents in a short time, penny stocks can do this.

This is the one of the main reasons why penny stocks are often and always target of manipulations and scams. False information is published in the Internet and through spam emails to trigger a price move. Millions of Dollars each year are lost through penny stock scams.

While there is nothing bad with penny stocks in general, you should be aware of all the risks and that it is a major playing field of fraudsters. You need to be an experienced trader or investor to be able to trade penny stocks wisely. Just because it looks cheap to buy doesn't mean you can't loose much.