Penny stocks do not have a definite universal definition. Different people have different definitions when it comes to penny stocks. Some people view penny stocks as stocks whose value is less than $1, while others view penny stocks as those priced under $5. Another opinion of penny stocks is that the total value of the company's tangible assets is less than $4 million and there should be no substantial operating history.

According to this definition, companies that have a legitimate business do not come under the category of penny stocks. The Securities Division categorizes penny stocks as those stocks that are valued under $5 and that trade outside the formal stock exchanges.

Penny stocks, in general, trade on the Over The Counter Bulletin Board (OTCBB) and Pink Sheets. In order to trade on formal stock exchanges, there are many regulations that have to be complied with. Most of the penny stocks companies will not meet these regulations.

Thus, they trade on OTCBB and Pink Sheets.

The OTCBB and Pink Sheets are electronic quotation systems that display the last transacted value of each penny stock, the volume of trade and the current bid and ask price of each share. Ask price refers to the price at which the seller is willing to sell the share, while the bid price is the price at which the buyer is willing to buy the share.

The OTCBB and Pink Sheets are managed by The National Association of Securities Dealers (NASD). Though NASD also manages NASDAQ, these systems are very different from NASDAQ.

Penny stocks are traded only in the secondary markets. Any company wishing to raise capital enters the stock market through an Initial Public Offering (IPO).

Each and every company has to comply with a set of guidelines issued by the Securities and Exchange Commission (SEC). Companies that do not meet these regulations are not listed. A company's stock becomes a penny stock when its value has fallen below the stipulated amount. The stocks are then moved to the OTCBB and Pink Sheets.

The main difference between companies trading on the OTCBB and Pink Sheets is that companies trading on OTCBB have to follow certain rules and regulations laid down by the SEC, mainly relating to public disclosure of its financial statements, while companies trading on the Pink Sheets do not have to follow any rules. As a result, they do not disclose any information to the public. This is the reason why any kind of information regarding these companies becomes very hard to obtain.

Investors should exercise extreme caution while trading the shares of companies listed on the OTCBB and Pink Sheets. Due to the thin volume of trade, they can easily be manipulated.

This paves way for the possibility of scams and frauds in penny stocks. With extensive research, investors may be able to find hidden gems in these stocks that will prove to be very profitable in the future. But, as a general note of precaution, investors must be wary about fraudsters who inflate the value of the stock. A thorough research will help the investors to choose the right penny stocks.