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What is a Penny Stock ?
As the name itself tells these refer
to low priced stock trading outside the major exchanges such as
NASDAQ, NYSE or AMEX. The price referred is usually les than
five dollars. In other words it can also be defined as a
tentative security of very small companies. It is despite of
market capitalization. The other terms used along with generally
are nano caps, microcp stocks and small caps. The status of
penny stock is determined by share price. Generally penny stock
trades over-the-counter such as on Pink sheets and the OTC
Bulletin board.
Risks involved in investing in penny
stock
It is difficult to sell the penny stock shares once it is owned
since there are difficulties involved in finding the quotations
for some penny stocks. Some new investors are attracted in
investing in such stock markets because of low price and the
potential for sudden gains which can be as high as hundred
percent. At the same time there are chances wherein the penny
stocks can drop to about ninety nine percent. The investors
should in a position to take the risk of loosing all their
investments.
The risks that are involved include
• Lack of financial reporting.
• Limited liquidity.
• Fraud.
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Since the shareholders in penny
stock are less in number it may not trade as many shares per day
as a big company does. The stock price can vary greatly if there
are any changes in demand or supply of the stock. This can
increase or decrease the stock price. Due to the lack in
liquidity it may be difficult in selling a stock specially when
there are no buyers and there are chances for the management or
market makers to make changes in the management. Low liquidity
levels provoke some traders to manipulate the stock prices which
can be done in many ways. Also stocks that are traded on the
Pink sheets have no listing requirements or regulatory when
compared to the standard markets. There are no measures that
protect the shareholders such as change in notification of
ownership of shares, no minimum accounting standards or reported
other material changes affecting the financial viability of a
company. Moreover, there are only minimal listing requirements
for a stock to remain on the OCTBB, which is incomparable to
NASDAQ or NYSE. The requirements are like making their filings
with the SEC on time. |
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Due to the above reasons penny
stocks can be used for a number of cheating schemes such as chop
stocks i.e. a trick in which the shares for pennies under
Regulation S and later sold illegally to domestic retail
investors or overseas, pump and dump – in this a large amount of
stocks are bought build it up and then sold after the investors
found it attractive and short and distort. Other tricks of penny
stocks include false e-mails, newsletter writers who promote
stock for fees, anonymous posting for stocks, spam faxes, fake
press releases given by the company, targeting foreign buyers
etc. Most of the company that approaches penny stock are either
newly formed or getting into bankruptcy. These companies have a
very poor track record.
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Problems
generally faced by the investors
The most common problems faced by the investors after buying the
penny stocks include two of the following:
• Off-shore brokers.
• Prejudiced recommendations.
Off-shore brokers: The
companies are allowed to sell the stock outside the United
States to foreign investors since they can be free from
registering the stock. This is the permission given by SEC under
Regulation S. The companies who have the permission will sell
the stock to the off-shore brokers, who later sell these stocks
back to the United States investors for a high profit. By cold
calling a number of investors who are capable of buying stocks
and providing them with attractive information the off-shore
brokers who are cheaters will use high-pressure boiler room
sales method to convince the potential investors to purchase the
stock.
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Prejudiced
recommendations: Some companies pay the individuals for
advertising falsely to recommend the company stock. The different
media that they use are radio shows, newsletters, Fake e-mails, and
television. All such advertisements must not be considered
seriously. Proper enquiry must be done regarding such cases like see
if the individual is paid for the service he/she is doing since this
is a snip of a bad investment.
Conclusion
This is a high risk area that is not suitable for all investors. Of
course there are many companies on the OTCBB and Pink sheets that
are of good quality and many companies are also working hard to get
higher into more reputable or reliable Nasdaq and NYSE. But still
there rare cases where in there are many good prospects in stocks
that are not trading for pennies. If still you are not able to come
out of the temptation of penny stocks it is always better to do a
broad research and understand what really it means where you are
getting to.
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Article Contributed By: Shilpa V
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