Penny shares can be fun but are the risky side of stock market investing. The definition of the penny share is a movable feast, but it typically sets an upper price limit. In the UK, a stock priced at less than £1.00 is widely considered a penny stock and, in the United States, the ceiling is around £3.00, encompassing stocks that were once priced at far below this level. But there are no hard and fast rules.

Liquidity is sometimes lacking in penny shares, which means they can be hard to buy and sell. Some penny stocks not listed on the London Stock Exchange Main Market have a small free float, meaning a limited number of shares in public hands. It can increase demand and send up the share price.

In reflection of the lack of liquidity, the spread (difference between buying and selling price) on a penny stock is typically wide. The share price can jump around based on only a little trading. A stock priced at 10p may rise 50 per cent on good news, whereas an old economy blue-chip stock will not. This type of gain is significant, although the spread will not enable shareholders to realize all of it. As investment guru Jim Slater has observed, elephants don’t gallop but fleas can jump to over two hundred times their own height. Of course it works the other way and the penny stock can fall in value no less sharply than it may rise.

In the stock market, unlike for washing powder, price per item is not in itself linked to value and penny shares are not in themselves a bargain. But the myth about penny shares is that they are better value because the price is low.

This is a reason for the popularity of share splits, where each share is split into two or more and the price is reduced proportionately. The overall holding is in theory valued afterwards as before but the psychological appeal of more shares for your money may in itself boost the share price. The same result may apply to scrip issues.

The excitement generated by penny shares benefits mainly the dealers and the tipsters. Penny stocks are often poor performers that have seen better days and companies at a higher price may be of much better quality. As a penny share investor, you must be selective. Some investors pile into a favourite penny stock because they fall in love with it. The gamble occasionally pays off. But a better bet is to buy on news of corporate restructuring, new management, or a likely takeover.

More often than not, penny shares see little movement. There are some disasters, and fraud has never been far away from this market.