However, academic research shows that the risk created by small market cap size and lower liquidity results in higher expected returns due to the size and liquidity premiums. The penny stock market has little liquidity, so holders of shares in penny stock companies often find it difficult to cash out of positions. Potential fraud that involves even what are considered very small or micro market cap companies can still involve losses of tens of millions of dollars. Prosecutors and the Federal Bureau of Investigation say that fraud is widespread in the penny stock market.

This is directly correlated to the price action of a security which, when talking about penny stocks, can change more rapidly than that of a large-cap stock. Volatility can be also understood as the frequency of large changes in the value of a given security in either direction. Conversely, the lower the volatility, the 'safer' the investment is. Typically, the higher the volatility, the greater the risk in investing in said securities. Volatility is “a statistical measure of the dispersion of returns for a given security or market index. This tendency makes the penny stock market volatile. Since penny stocks are inexpensive, investors often buy large quantities of shares without spending much money. Market capitalization or 'market cap' is the total dollar market value of all of a company’s outstanding securities. When considering penny stocks, investors and experts in the field recognize the low market price of shares and its correlation to low market capitalization. Penny stocks can include the securities of certain private companies with no active trading market. Penny stocks can also trade on securities exchanges, including foreign securities exchanges. Over-the-counter exchanges that list penny stocks include the OTC Bulletin Board (which is a facility of FINRA) or OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.). In 1934, when the United States government passed the Securities Exchange Act to regulate any and all transactions of securities between parties which are 'not the original issuer', the SEC at the time disclosed that equity securities which trade for less than $5 per share could not be listed on any national stock exchange or index. The term 'penny stock' refers to shares that, prior to the SEC's classification, traded for 'pennies on the dollar'.

Penny stocks are priced over-the-counter, rather than on the trading floor. Securities and Exchange Commission (SEC) uses the term 'Penny stock' to refer to a security, a financial instrument which represents a given financial value, issued by small public companies that trade at less than $5 per share. Penny stocks are common shares of small public companies that trade for less than one dollar per share. Common shares of small public companies that trade for less than one dollar per share

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