Penny Stocks: Why You Should Always Stay Away
With the exception of some large foreign firms, investors should generally avoid stocks that trade over-the-counter.
- (opens in new tab)
- (opens in new tab)
- (opens in new tab)
- Newsletter sign up Newsletter

Penny stocks – those that trade for low prices, often less than a dollar per share – are dangerous. Period. Indeed, with a few exceptions, investors should steer clear of these uber-cheap stocks, which typically trade over-the-counter and not on a major exchange.
Call them penny stocks, microcaps or OTC stocks; by any name, they’re bad news. False promises of quick and painless riches are easier to fall for when an investment can be made with so little money up front. An investor might think, "How risky could it be?"
Plenty. Per the Securities and Exchange Commission: “Academic studies find that OTC stocks tend to be highly illiquid; are frequent targets of alleged market manipulation; generate negative and volatile investment returns on average; and rarely grow into a large company or transition to listing on a stock exchange.”

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
We’ll break down what all that means below, but suffice to say, the SEC is not a fan.
Why Penny Stocks Are So Dangerous
To be clear, this is not to say that every penny stock or OTC company is a scam. The danger is that the over-the-counter market is where the scam stocks live. Think of it as a bad neighborhood. Just being there can make you a mark for a con.
For some background, the OTC market is different from exchanges like the New York Stock Exchange or Nasdaq, where trading is centralized. There is no one OTC exchange. Instead, the OTC market connects buyers and sellers over a computer- and telephone-based system. Any stock that does not trade on the NYSE, Nasdaq or other established U.S. exchange can trade over-the-counter. These securities also are known as “unlisted stocks.”
Typically, OTC stocks tend to be highly risky microcap stocks (the shares of small companies with market capitalizations of under $300 million), which include nanocap stocks (those with market values of under $50 million).
The SEC has long warned investors about the high risks associated with such stocks. The Financial Industry Regulatory Authority (FINRA), the industry’s self-regulatory agency, likewise flies a red flag over the buying and trading of OTC securities.
That’s because companies that list OTC aren’t required to file periodic or audited financial reports as they must do if they are listed on a major exchange, such as the NYSE or the Nasdaq. In other words, there’s no way to know if they’re telling the truth when they claim to have sales and profits. The major exchanges also have listing requirements; OTC stocks don’t. For example, a company must have at least 400 shareholders and a market value of at least $40 million to get a listing on the New York Stock Exchange. The OTC market makes no such requirements.
Put it all together, and it makes it easier for unscrupulous managers to lie about their business prospects or commit securities fraud.
But that’s not all. The shares that change hands on the OTC market tend to be “illiquid,” meaning they often trade in low volumes and have a limited number of buyers and sellers. That can make it difficult or impossible for investors to buy or sell shares at the prices they want.
That lack of liquidity also makes many OTC stocks the perfect vehicles for “pump-and-dump” schemes where stock promoters lure investors to buy shares, increasing the stock price. Once the price gets high enough, the pumper sells his shares, causing the stock to fall and leaving investors with poor returns, or even losses. Anyone here see The Wolf of Wall Street?
To protect investors from falling for these schemes, the SEC suspended trading of more than 800 microcap stocks – more than 8% of the OTC market – between 2012 and 2015. Once a stock has been suspended from trading, it cannot be relisted unless the company provides updated financial information to prove it’s actually operational. Since that rarely happens, trading suspensions can essentially render the shares worthless.
Legitimate OTCs
Be that as it may, there is one segment of the OTC market that investors need not fear.
Amidst the riff-raff, some of the biggest, most respected foreign companies in the world list their U.S. shares over-the-counter instead of on the major U.S. exchanges. Here, you’ll find the American depositary receipts of The Industrial & Commercial Bank of China Ltd. (IDCBY (opens in new tab)), which happens to be the biggest bank in the world. You also can buy shares of Switzerland’s Nestlé (NSRGY (opens in new tab)), the largest food company in the world; China’s Tencent (TCEHY (opens in new tab)), one of the country’s largest internet service providers; and Japanese gaming giant Nintendo (NTDOY (opens in new tab)).
Why would major, international publicly traded companies rub shoulders with firms that issue highly speculative penny stocks?
The reason has to do with cost and convenience. For example, foreign firms listing on the NYSE or Nasdaq must adhere to the SEC's stringent reporting requirements. And they must prepare two sets of reports for all financial disclosures – one to conform with international accounting standards, and another that follows the generally accepted accounting principles (GAAP) used in the U.S. Companies trading OTC avoid the burden and expense associated with such compliance.
In sum, the OTC market can give foreign firms cheaper and easier access to the vast pool of U.S. equity investors.
The bottom line is that with the exception of large, established foreign firms, OTC stocks come with too many risks. It’s simply not possible for the average investor to know if every OTC company is on the up and up. And even legitimate tiny companies can fail virtually overnight. The dangers lurking in OTC stocks far outweigh the vanishingly small potential for rewards.
It’s easy enough to lose money trading stocks. Why make it any easier?
Dan Burrows is Kiplinger's senior investing writer, having joined the august publication full time in 2016.
A long-time financial journalist, Dan is a veteran of SmartMoney, MarketWatch, CBS MoneyWatch, InvestorPlace and DailyFinance. He has written for The Wall Street Journal, Bloomberg, Consumer Reports, Senior Executive and Boston magazine, and his stories have appeared in the New York Daily News, the San Jose Mercury News and Investor's Business Daily, among other publications. As a senior writer at AOL's DailyFinance, Dan reported market news from the floor of the New York Stock Exchange and hosted a weekly video segment on equities.
Once upon a time – before his days as a financial reporter and assistant financial editor at legendary fashion trade paper Women's Wear Daily – Dan worked for Spy magazine, scribbled away at Time Inc. and contributed to Maxim magazine back when lad mags were a thing. He's also written for Esquire magazine's Dubious Achievements Awards.
In his current role at Kiplinger, Dan writes about equities, fixed income, currencies, commodities, funds, macroeconomics and more.
Dan holds a bachelor's degree from Oberlin College and a master's degree from Columbia University.
Disclosure: Dan does not trade stocks or other securities. Rather, he dollar-cost averages into cheap funds and index funds and holds them forever in tax-advantaged accounts.
-
-
Considering a 1031 Exchange? The Rules You Need to Know
Taxes are an inevitable part of investing in real estate. You can, however, defer or avoid paying capital gains taxes by following some simple rules of a 1031 exchange. Yes, you read that correctly!
By Daniel Goodwin • Published
-
Stock Market Today: Stocks End the Week on a High Note
Intel stock plunged after a big earnings miss, but encouraging inflation and consumer sentiment data created tailwinds for the broad market.
By Karee Venema • Published
-
Stock Market Today: Stocks End the Week on a High Note
Intel stock plunged after a big earnings miss, but encouraging inflation and consumer sentiment data created tailwinds for the broad market.
By Karee Venema • Published
-
Kiplinger's Weekly Earnings Calendar (Jan. 30-Feb. 1)
stocks Check out our earnings calendar for the upcoming week, as well as our previews of the more noteworthy reports.
By Karee Venema • Published
-
Stock Market Today: Stocks Climb After Tesla Earnings, GDP
The electric vehicle maker reported record profit and revenue for the fourth quarter.
By Karee Venema • Published
-
Stock Market Today: Microsoft Earnings Weigh on Stocks
While Microsoft reported top- and bottom-line beats in its fiscal Q2, shares declined on disappointing guidance.
By Karee Venema • Published
-
The S&P 500 Dividend Aristocrats Are Getting 3 New Members
Dividend Aristocrats The index of stocks that have upped their dividends for at least 25 straight years is about to get longer.
By Dan Burrows • Published
-
Stock Market Today: Dow Gains After Busy Day of Blue-Chip Earnings
Travelers and 3M were two Dow components that reported earnings today.
By Karee Venema • Published
-
Stock Market Today: Stocks Climb After Spotify Job Cuts
Spotify became the latest company to announce layoffs, while Salesforce climbed on activist investor news.
By Karee Venema • Published
-
Stock Market Today: Netflix, Alphabet Lead Rally in Tech Stocks
Netflix reported much higher-than-expected subscriber growth, while Wall Street cheered Alphabet's layoff announcement.
By Karee Venema • Published