Penny stocks are very related to pink sheets, and you should have an understanding of both if you plan on investing in the stock market. It is an electronic quotation system for many OverTheCounter (OTC) securities. The name comes from the colour of the paper the quotes were originally printed on. Most pink sheets are associated with penny stocks nowadays.

1. Penny Stocks - What Are They?

The term penny stock simply refers to a stock that isn't worth very much - under $5.00 per share. They can be traded normally, but you should note that they are very high risk investments. Although they can be traded on regular stock exchanges, companies that are listed in the Pink Sheets usually do so because they cannot meet the requirements of other exchanges like the NYSE and Nasdaq. Be careful when investing your money.

2. Unregistered

The Pink Sheets is not a registered stock exchange. As such, it can list companies that would otherwise be unable to raise capital through stock offerings. Although it is not regulated by the Securities and Exchange Commission (SEC) its trading system is only accessible by brokers licensed by the National Association of Security Dealers (NASD) and these brokers are required to follow NASD regulations. Companies that issue stock listed in the Pink Sheets must follow Federal and State security laws.

As an unregulated exchange, stocks listed in the Pink Sheets carry more risk than stocks on the big exchanges like AMEX. The lack of financial data means that companies may be facing bankruptcy and are issuing stock in a last ditch effort to stay afloat. Not all companies are in dire straights, however. Some may be in the process of becoming listed on the regular exchanges and use the Pink Sheets as an intermediate step to raise capital.

3. Get A Dealer

To get listed in the Pink Sheets a company needs a broker dealer to quote the stock. The only requirement is that the broker is a member of the National Association of Securities Dealers (NASD). Once listed, the company remains in the Pink Sheets as long as the stock is quoted. It can happen that a stock that no longer exists still is quoted in the Pink Sheets a situation that highlights the need for researching any company that lists here.

The main advantage of buying Pink Sheet securities is their low cost. Investors who hope to get in on a new company right at the beginning can pick up stock for literally pennies. In the event that the company does well and grows the small initial investment will pay large dividends.

4. High Risk

There is a very real risk, though, that the company will simply vanish, leaving behind valueless stock issues. The investor interested in penny stock in the Pink Sheets should be prepared to lose all. For this reason, Pink Sheet investments should represent only a small portion of an overall investment portfolio.

5. Hard To Sell

An even bigger issue is that the stocks have very low liquidity - this means it will be difficult to resell your stocks after you purchase them to make a profit. Unless, of course, your company hits it big in which case you will most likely be a millionaire because you bought stocks when they were extremely cheap and now the company is doing so well the stocks may be worth ten times what they were previously.