As the name suggests, penny stocks are those that are low in cost and high in volatility.
They have very low market capitalization, are mostly illiquid, and are usually listed on a smaller exchange. These stocks are very speculative in nature and are considered a bit risky because of lack of liquidity, smaller number of shareholders, large bid-ask spreads and limited disclosure of information.
Shares that trade below $1 are usually called penny stocks. But this basket also includes stocks priced under $5. Penny stocks can at times be volatile, but some of them also have the potential of turning a small investment into a fortune. For example, if you own 50,000 shares of a penny stock priced at $1, even a $1 rise in the share price can give you $50,000 in a single day.
This is not possible in the case of a large stock, because it would require large capital to buy such a large volume of shares. Generally, stock exchanges put these types of stocks in a different category, called as trade-to-trade basket. In this category, no intraday share trading is allowed.
Transactions have to be compulsorily settled on gross basis, which means you must deliver the shares on the same day if you have sold them or take delivery if you have bought them. This procedure helps in avoiding sudden price rises and loses which may occur due to artificial created market conditions.
One can move the stock by buying thousands of shares and create a spike without leaving any cue for the average investor to know whether the spike in price is genuine or manipulated. Also, penny stocks are more prone to scams, as they are often not regulated by a national-level stock exchange. Hence, while investing in Penny Stocks, one should conduct a thorough research and try to buy from only top brokers.