LEVEL: BEGINNER
There are many different types of common stocks available for investors to buy and sell both on and off exchanges like the New York Stock Exchange (NYSE) and NASDAQ. The most popular and common are the so-called large-cap stocks like IBM (IBM), AT&T (T), Coca Cola (KO), Apple (AAPL), and other household names who often pay dividends as well as offer investors fractional ownership in the company.
In terms of sheer number of stocks traded on any given day, these are just the tip of the iceberg. Several categories of stocks exist, and investors should be aware of the nature of each before jumping into the market.
Penny Stocks
Penny stocks are easily the most controversial and volatile equity investments around. Even the definition is controversial; a generation ago most would agree that penny stocks trade below $1 per share (hence they cost pennies). Nowadays, some would say any stock under $5 is a penny stock. No matter how you define it, penny stocks are considered risky and volatile because they are so cheap and so close to the base points that equities trade at that they will rise and fall be several percent per day, and can rise and fall by 20% or more in a single day.
Penny stocks are also often manipulated by “pump and dump” style charlatans who will praise a stock to the skies amongst a social network and encourage a lot of people to buy the stock that he or she already owns. Then when the stock has risen, the charlatan will dump the stock. In recent years, other charlatans have begun doing this the other way: warning of dangerous penny stocks that should be avoided, and then selling those stocks short.
Over-the-Counter (OTC) and Pink Sheet Stocks
Over-the-counter stocks (OTC or sometimes OTCBB) are securities traded off of a formal exchange like the NYSE and NASDAQ. These are usually penny stocks, although not all OTC stocks trade at what many people would consider penny-stock levels.
Like penny stocks, OTC stocks carry huge risks. These stocks are usually in companies that are small and cannot make the requirements to be listed on an exchange. Those requirements exist to protect investors and make the market stable, so stocks that don’t make the cut are by their nature more volatile and risky. Companies on OTC stocks also do not need to fulfill exchange requirements, meaning that their accounting details are less reliable and fraud is more likely than on an exchange. All of these things make OTC stocks risky.
Pink sheet stocks are like OTC stocks, although their history is different. They are usually demarcated by a .PK at the end of a ticker. Originally printed on pink paper, these companies have been known as unreliable for the same reasons as OTC stocks: they do not need to meet the requirements set by the SEC or the formal exchanges.
Nano and Micro Cap Stocks
Nano cap and micro cap refer to the size of the company’s value. Nano-cap stocks are companies that are worth less than $50 million. Micro-cap stocks are companies that have a market capitalization of between $50 million and $300 million. Since market cap determines the value of the company as it is seen by the market at the time, these valuations can differ radically from how much the company would actually be worth if it sold everything (in other words, the company is liquidated). This is known as the “book value” and market capitalization usually differs substantially from book value.
Nano-cap and micro-cap stocks are almost always OTC or penny stocks, but companies can jump from nano and micro-cap levels very quickly to become bigger stocks. When this happens, they can also qualify for entry onto the exchanges. The move from OTC to exchange listing is a major moment for any public company, and when this move is announced, it will usually raise the value–and stock price–of the company substantially.