Penny stock
Penny stock is a term referred to a stock which can be bought at less than $5. These securities are of very small sized companies having no financial strength. Penny stocks are also sometimes called micro caps. Micro caps trade is generally classified on the basis of market capitalization where as penny stocks are classified on the basis of the price of the stocks in the market. These stocks are traded outside the major stock exchanges of the world, like NASDAQ, NYSE and AMEX. Deemed as a dyslogistic stock, Penny stocks are basically traded on foreign securities exchanges. These stocks are of specific private companies having no active trading taking place in the share market.
Penny stocks are speculative in nature, and is generally traded on the "over the counter" referred to as Pink Sheets or OTCBB. As it is speculative in nature, Securities & Exchange Commission has also termed it as high risk investments. New investors and traders are very much interested in the penny stocks as they are very affordable and have immense potential for few hundred percent gains within few days. This is highly governed by the highs and lows, if extreme crashing down of the share price occurs; there is a huge chance of loosing all your money. The investors in Penny stocks should be mentally prepared that they might loose all their investments. Penny stocks/Micro Caps stocks are much riskier than the regular stocks and just have an equal comparison with the blue-chip.
Since Penny stocks are related with small sized companies, they have very less liquidity and have high chances of fraud and fraudulence. Sometimes, the companies that do not meet the requirements of the SEC are removed from the SEC and brought down to Pink Sheets or OTCBB. These Pink Sheets or OTCBB have almost no specific requirements for getting listed as compared with such broader stock exchanges NASDAQ, NYSE and AMEX. Therefore, there is an extra chance of loosing money. You will find that there is a big difference between the price of the penny shares. The buying price differs to an extent with the selling price, as the selling price is almost negligible as compared to the buying price. The selling price could be much less than you paid for them over the counter.
Basic Rules
Before investing, SEC confirms that the company (in which you are investing) must have a written document from the investor showcasing all the risks that the penny stock involves. Then, the company must quote the customer with the current market price (if, any) and the compensatory amount the investor will receive for transacting the trade with the following company. Last but not the least, company must send a monthly statement to the investor regarding the value of each penny that customer hold in the company's account.
Internet SPAM
We are all very well known to the number of spams we receive in our mails every day. The growth of spammers and spams sends approx 50 billion spams everyday, of which there are 15% of spams containing frauds of Penny stocks. The spammers buy the stock before sending the spam and then they earn approx 6% from the same. The investor can loose almost 8% of his total investments within two days.
Fraud
Securities and Exchange Commission (SEC) has warned all investors regarding the fraud of Penny stocks.
Explaining how it actually works: A company will print a very impressive press release showing it high liquidity position and great future prospects. This will be greatly followed by newsletters referring it as the "Hot stock". This scheme of showcasing the company as high profile is called "pump and dump" scheme. Chat rooms and bulletin boards will compel you to buy the stocks. The fraudsters behind the scene will once sell the shares at the peak time and stop hyping about it and the investors investing in the scheme loose their money. It is easy to cook with a small sized company's share as there is less information available about the company.
It is not true that all the stocks at the Pink sheets or OTCBB are frauds but according to one famous Business Week article calculated that "chop stocks" make up perhaps half the 85 million-share daily volume of the OTC Bulletin Board.
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