In Wall Street urban legends, penny stocks feature prominently as the diamond in the rough no one else noticed. The pennies risked by the small time investor turn into dollars and then into million dollar portfolios. While that is possible, investors need to understand the pitfalls as well as the potential gains.ExchangesShares that sell for pennies or even fractions of a penny are most commonly traded "over the counter" and not listed on the major exchanges. These companies are often very small, just beginning to make public share offerings or both. Quotes for penny stocks are listed in the "Pink Sheets" or on the Over the Counter Bulletin Board (OTCBB). Companies listed by the OTCBB have to be compliant with SEC reporting regulations while those listed in the Pink Sheets do not. The few found on the NYSE or NASDAQ exhanges are often shares in companies facing bankruptcy and soon to be dropped from the exchange.FeesBecause they aren't listed on the major exchanges many brokerage houses won't deal with penny stocks or charge extra fees to trade them. The extra fee might be a higher commission or be based on the number of shares traded. Since documents are often physically transferred between the issuing company and the brokerage service, an investor can also expect a possible "document transfer fee" (DTF). The DTF can range into the hundreds of dollars.TradingPenny stocks can also be cursed by low volume trading so that entry and exit points for trading are limited. The few participants in the market and large institutional holders can determine to a how many shares are traded and at what price. Conversely, they can enter phases of extreme high volume as victims of predatory "pump and dump" schemes. Investors should watch for signs of unusual trading activity.As with any kind of investing, the key is due diligence which can be difficult given the lower reporting standards. Still, a careful investigation may give the small-time investor a chance to invest in a future corporate giant and get in on the ground level with only a few pennies risked.