This article is by no means a comprehensive listing of deceptive practices used in penny stock scams, and we are sure that there are many different ways that people can be deceived. However, it is important to highlight some of the methods that people use to fraudulently promote and profit from penny stocks.
If you receive an email alert or several saying that a stock “will skyrocket through the roof”, be careful, be very careful. If you come across hype on stock investing message boards about the latest research report promising a sure winner, be extra cautious. If a much-hyped stock has on average very thinly traded volumes but research reports are peppered with catchy phrases such as “sustainable momentum”, “fast money” and “ready to explode”, you can be sure you’ve just come across a penny stock scam in the making.
What are Penny Stocks?
Penny stocks are defined as small-cap stocks with a share price of less than $1.00 a share. In the US, the SEC defines it as less than $5.00 a share. They have a low share price, a small market capitalization and are too small to meet the listing requirements of a major stock exchange such as the Toronto Stock Exchange (TSX). In Canada, penny stocks are more likely to trade on the Toronto Venture Exchange or in the US, on the Over-the-Counter Bulletin Board (OTC, formerly known as the “pink sheets”).
What is more important is that they pose several risks to investors because of their low trade volumes, wide bid-ask spreads and that they observe limited disclosure requirements. Basically, what this means is that it’s hard for you to conduct your own due diligence before investing. Penny stocks don’t have to file as frequently and have fewer reporting requirements than those expected of stocks listed on the Toronto Stock Exchange for example. Management who are out to deceive can just as easily issue misleading statements. If you have already lost interest, stick to learning how to buy stocks that are listed on the major exchanges. These stocks are much lower risk compared to ones traded Over-the-Counter.
However, investors fall for penny stock scams time and time again because they feel that they can find the next “big thing” that turns into an Apple or a Google. While it’s true that there are many companies which start small and turn out to be very successful, remember Apple, Google, Microsoft or any of the game-changing companies were never listed at less than $5.00 or $1.00 per share. As a side note if you look at long term stock charts for Microsoft often it will show that the initial share price was less than one dollar; however that is because the chart has been adjusted for stock splits.
Lets go over some basic penny stock scams that you may run into
The pump and dump scheme:
The pump and dump is a fairly common and fairly easy penny stock manipulation to pull off. An investor who owns a high percentage of stocks in a particular company will “pump” the companies value through social media, penny stock newsletters and fake news. Naive investors purchase these stocks, not realizing they are about to get scammed. The mass purchase of the stock from investors spikes the price and the scammers sell at this high point. The price then plummets considering they own a large portion of the stock, and investors frantically try to get rid of their shares, to little or no avail.
The short and distort scheme:
The short and distort is another common penny stock scheme and it is actually the direct opposite of the pump and dump. Instead of “pumping” up a certain security, scammers will take short positions in otherwise credible penny stocks and begin to drop the value of these shares via fake news on social media and newsletters. When the value hits a low, the short sellers close their positions with their brokers for a massive profit.
As penny stocks don’t have to provide much information, you don’t get access to track records to build up a sense of history about the company. A penny stock can be a newly formed company or it could be one fast approaching bankruptcy – there’s really no way for a serious investor to figure out the stock’s earnings potential. The combination of low price, low liquidity, inadequate information and wide-spreads ensure that penny stocks can be easily manipulated. If after reading all this you’re still interested in trading penny stocks, check out this online discount broker review.