A penny stock is, essentially, any stock trading for under $5.00 USD per share. Large firms and brokerages tend to ignore penny stocks, considering them unfit for market research or use as loan material against their own stock.
Because of their underground nature penny stocks can possess above-average potential for profit-making. However, information on penny stocks is usually difficult to come by for the exact same reasons.
Smaller online market research newsletters and organizations, for the most part independent, do sometimes focus their attention on the stocks overlooked by larger firms. Without a large brokerage’s high overhead necessitating high-volume transactions, smaller online firms can afford to spread their attention around, including to so-called penny stocks.
These small online brokerages and market research teams represent a riskier market not because of any increased tendency toward fraud but because penny stocks are a notoriously unfaithful market, more subject to fluctuation than a typical market sector.
Penny stocks occupy a different market arena than traditional stock, one almost entirely unregulated by the Securities and Exchange Commission. Given this lack of regulation it’s no surprise that this kind of low-end fraud takes place with disturbing frequency.
Because the majority of penny stocks are not widely traded, especially those trading for cents or fractions of cents, they are prime targets for price manipulation.
Price manipulation can take many forms, but most often it involves a group or individual buying huge blocks of shares, sometimes upwards of hundreds of thousands, even millions, and then beginning an aggressive media campaign to push interest in the stock around common internet watering holes and via spam-style e-mail tactics.
Increased demand from hooked clients forces up the value of the stock, often skyrocketing it, and the “pumper”, the party or parties responsible for attracting commerce in the first place, sells of their shares at a profit and vanishes.
Perhaps the most infamous “pump and dump” scam perpetrated in recent years was the LEXG disaster in which LEXG, a paid promotional stock with zero income, rose to a net value of over $350 million dollars before initial pumpers crashed it and vanished. Every year huge numbers of such scams are perpetrated against the investing public, and hundreds of millions of dollars are siphoned away from legitimate investors.
Even the oft-discussed greatest advantage of the penny stock, its high mobility over short periods of time, is also its greatest weakness. As an investor, small or large, the potential for total capital loss is very significant. Even a legitimate penny stock, should you find one, could take a nosedive at any moment.
Lack of liquidity can also make sale of penny stocks a difficult, or even impossible, prospect. Getting caught in a quarter become of low sale potential could damage your portfolio significantly, and the tight time frames in which penny stocks change valuation makes the possibility even more significant. This kind of situation should be avoided at all costs.
Bottom line, without a respected broker with whom you have a personal relationship, and without the financial means to take a hit, trading in penny stocks is too high-risk and the potential for being defrauded too high. Unless you’re a born risk-taker try to stick to the highway and leave off-roading to the daredevils with money to burn.