Penny stocks have, over the years, developed something of a bad reputation among professional investors. Often, this is the result of their low price and the stigma attached to trading such “worthless paper.” Additionally, the liquid nature of the microcap market has further increased that stigma. However, advances in how stocks are traded and studied have lead to an increase in interest in the traditionally maligned penny stock market.

The term penny stock applies to a category of company shares that are typically valued at under five dollars each. They go under several other names, like microcap or small cap stocks, which are generally interchangeable. Penny stocks got their name from the early days of public trading, when low valued stocks often literally cost pennies to purchase. Currently penny or microcap stocks tend to be sold by young, small companies attempting to establish capital resources to expand operations or transition from a venture capital framework to a more traditional profit based model. According the SEC, the aggregate value of the average microcap stock is $6 million dollars for all of the shares sold by a company. The small size and value of these stocks means that they aren't as tightly regulated by the Securities Exchange Commission, which in turn means that they have a reputation as risky investments. While this has never been entirely true, recent changes in the way the SEC regulates trading in penny stocks and the nature of the enforcement of these regulations has greatly reduced fraudulent investments.

That isn't to say that microcap trading is risk free by any means. The dynamic nature of these stocks, which are generally traded over the counter by brokers rather than through the larger exchanges, means that they can be risky investments, best suited as a small part of a portfolio designed to exploit potential surges in the market. Given all this information, why invest any part of your portfolio in penny stocks at all?

There are many good reasons to invest in penny stocks, most of which are inherent to the low price of the stock. Large volumes of stock can be purchased for relatively little initial investment, which means that small changes in stock value can generate relatively large profits. The low individual cost of these investments means that, as long as you don't over concentrate in a single penny stock, your speculative investment is less likely to cripple your portfolio as a whole. Investing in a large number of different penny stocks is not only possible in a way that isn't with conventional stocks, but it can spread the risk around so a failure of a particular stock isn't crippling to the speculative portion of your portfolio.

The ability to purchase a large number of these inexpensive stocks without over exposing yourself or putting all your eggs in one basket allows you to leverage your stock ownership to position yourself as a large percentage of the total stock offered by a company. While this will probably not end up with an individual investor owning a controlling portion of the company due to controls on how the stock is sold, it can improve the profits available on the sale of the stock. Essentially leveraging the volume of stocks can increase the shares owned and therefore the profits from the margins.

Another possible reason to invest in these little known stocks is the potential to pick the proverbial winner. Penny stocks are generally sold by companies that are new and unknown, and while many companies go out of business, there's always the chance that the company you invested in could go on to become a legitimate success story. Every company starts somewhere and if you do your research right or even just get lucky with the relatively minor initial investment from the speculative component of your portfolio you could stand to make a lot of money on an investment opportunity that has gone overlooked by the majority of professionals. The inherent fluidity of these kinds of investments means that both the risks and the rewards are great, while the inexpensive penny stocks allow anyone to get involved in their purchase. Regular stocks, with extensive histories may be more stable but they offer less potential for gain as a result.