Penny stocks are stocks of small public companies priced at or below $5. Such companies do not trade on the major national exchanges like the New York Stock Exchange or the NASDAQ. Instead, they trade over the counter on the OTC Bulletin Board. Penny stocks are bought mostly by investors looking for young and promising growth companies. They can buy such stock with the cash in their brokerage account, or in some rare cases they can buy shares on credit.
Penny Stock Restrictions
Buying a stock on margin means you are borrowing money for the investment. People buy stocks on margin if they have limited funds in their brokerage account to make the full purchase of shares. The margin rate acts like a down payment that allows the trader to buy additional shares. Blue-chip stocks may be bought on margin depending on the amount of cash a client has in their brokerage account. However, the Federal Reserve Board sets the rules for OTC stocks, and not all can be purchased on margin.
OTC Stock List
The Federal Reserve Board usually publishes a list of stocks that can be bought on margin, published quarterly. It includes the names of public companies that either abide by the rules of the National Market System or those that trade on the national securities exchanges. Since penny stocks do not trade on the national securities exchanges, investors should first consult the list of OTC stocks for companies that can be bought on margin.
The Federal Reserve sets the minimum requirement or the margin level that investors can buy stocks on credit. For many blue-chip stocks, the margin requirement is 50 percent. This means an investor who has $10,000 cash in their trade account can be allowed to borrow an additional $10,000 shares of stock. For penny stocks the margin requirement can be up to 100 percent, which means investors have to put down the full cash amount to make the purchase .
Brokerage firms can make an exception for some $5 stocks as long as they are listed on an exchange. However, should the stock be delisted from the exchange the higher margin rules may apply accordingly. The margin rules for penny stocks are stricter. Even though the shares are considered to be much cheaper, stocks from young companies can present a risk. Their prices are volatile, which is one more reason brokerage firms may require 100 percent margin level.
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