If you're intrigued by the potential to find such exponential gains, it could be worth diving into the murky waters of penny stocks. Investors should conduct thorough due diligence before taking chances on any penny stock. For example, it might have looked like a good bet to invest in the ailing Walter Energy Co.
The stark contrast between these two stocks lies in company fundamentals. Walter was an established company in metallurgical coal, an aging sector prey to cyclical demand and political pressures.
When world leaders made commitments to lowering greenhouse emissions, this placed more downward pressure on Walter Energy, which already was reeling from a worldwide coal supply glut and slowing demand from China.
Walter ended up selling its assets to two companies in By contrast, Inovio is a speculative biotechnology play with strong partnerships in its cancer vaccine portfolio, which offers strong buyout potential.
As of , a buyout hasn't happened, but the stock continues to sell off and then see huge upside moves that quickly dissipate. You should have the complete picture as to why the stock's trading at its current price before you even think of buying it. Just like with any stock purchase, when considering buying penny stocks, fundamental analysis and due diligence of the company's management quality can help lead to the winners and avoid the losers.
Because this period is marked by a slew of start-up firms particularly in tech or biotech , all of which have high costs and little-to-no-sales to date, most of these companies will trade at very low prices owing to their speculative nature.
The perfect example is the tech boom and crash of the late s. Many tech startups started life as penny stocks and then experienced astronomical gains in their market caps and valuations as investors snatched up anything related to the then-novel concept of the Internet. Industries that offer binary outcomes for most of its companies will unsurprisingly contain a plethora of penny stocks.
The Canadian TSX Venture Exchange was the home of many resource-based penny stocks that took off during the commodity boom of the s.
Then the party ended, and most of the stocks crashed back to nothing, similar to many technology stocks in the crash. However, traders can still take advantage of binary-type companies when conditions are favorable, such as when commodities are booming. But investors in these areas must also realize that the stocks can fall just as quickly as they can rise. More importantly, experienced and ethical management that have a vested interest in the company via share ownership can provide investors with a sense of security.
This is the opposite of the pump-and-dump. In this case, the scammers use short-selling to make a profit.
An investor who sells short is betting on a stock's price falling. Using the shorting strategy, the investor borrows shares from a broker and immediately sells them in the open market.
If it price falls, the short seller scoops up shares at the lower price. The borrowed shares are then returned to the lender and the short-seller pockets the difference in profit.
Penny stock scammers short-sell a stock and then make sure its price falls by spreading false and damaging rumors about the company. Investors hold a losing stock, while the short-sellers make money. Sometimes a private company merges itself with a public company so that it can become publicly traded without the hassle and expense of going through traditional listing methods.
This makes it easy for the private company to falsify its earnings and inflate its stock price. Gold, diamonds, and oil have always had an allure, and mining scams can be traced back through the history of mankind.
One of the most famous mining scams was Bre-X, in the mids. Founder David Walsh falsely claimed his company had discovered a massive gold mine in Burma. When the company collapsed, most investors lost everything. Anyone with an advertising budget can be a guru. Sadly, they often gain a devout following. This type of false advertising promises to reveal a special secret that the financial guru used to acquire a lakefront mansion and a fancy car.
The expert promises to share penny stock trading secrets with you for a one-time low sum. Trash that email or envelope. There is no one-size-fits-all path to riches in the stock market. Also avoid pitches from anyone claiming to be the new Thomas Edison and offering you the opportunity to invest in the biggest thing since the lightbulb. The scammers offer shares of a stock with the stipulation that they cannot be resold for a certain period of time. The investors are told that there is a huge demand for this stock.
By the time the SEC gets around to closing these scams down, the investors are left with nothing. Companies that operate outside the U. Penny stock scammers love this. They buy cheap and unregistered foreign company shares and sell the stock to investors at an inflated price. The thieves make money while U. The penny stock world is rife with market manipulation, fraud, and chicanery.
Investors should know that such abusive practices aren't the exclusive domain of penny stocks and micro-caps, as the notorious cases of Enron and WorldCom prove. That said, how can you avoid being scammed by dishonest penny stock promoters who are out to make a fast buck? Below are some suggestions. Promoters hire newsletter writers to write flattering reports about their stocks. They make a convincing case for investing in dud penny stocks, using hyperbole, outlandish projections, and, in some cases, deliberate distortion.
These promotional pieces look very similar to legitimate research reports. The penny stock investor has to learn to distinguish between stock promotion and equity research. Penny stock companies are unproven. It's rare for companies that you've already encountered in your daily life to be among the ranks of penny stocks. Rather, penny stocks are usually those of less established companies that have yet to prove that they can endure and succeed. Penny stocks don't trade on major stock exchanges.
Instead, penny stocks typically trade over the counter, or OTC. Efficiently buying and selling shares of penny stocks can also be comparatively difficult because stocks that are less frequently traded are more illiquid, meaning that wide ranges between bid and ask prices are common.
Penny stocks are sometimes the targets of pump-and-dump schemes. Con artists often target penny stock investors by promoting a penny stock company as the next hot investment. Building hype about a penny stock can pump up its share price, and the price increase itself can be misleadingly cited as evidence of the company's success. After the stock price increases, the scammers typically sell dump their shares for profit and stop promoting the stock. The share price then usually declines, causing large losses for the late-arriving investors who believed the hype.
Fortunately, there are better alternatives to penny stock investing. Thanks to the rise of fractional share trading, which enables purchases of less than one share, you can often invest in stocks for which the share price is extremely high. For instance, a single share in a company like Amazon. Moreover, high-quality companies can have low share prices. These are just a few of the stocks that you can buy without spending a lot for each share.
Investors who are willing to assume high risk in order to achieve high returns have plenty of stocks from which to choose that offer better risk-reward dynamics than penny stocks. If we can't persuade you to not invest in penny stocks, then you should at least follow these basic precautions to protect your portfolio:. Determine the maximum dollar amount that you're willing to lose.
Figure out how much money you can afford to lose and then limit yourself to investing that amount. That way, if your investment goes under -- as many investments in penny stocks do -- then you won't be in real financial trouble.
Don't pay commissions if you can avoid them. Make sure that the brokerage firm you use doesn't charge trading commissions. Many brokers have gone commission-free on stock trades but with a catch -- commissions or special fees are still assessed by some brokers for stocks with share prices below a certain level. Get a second opinion. There is no reliable business model or accurate data, so most penny stocks are scams that are created to enrich insiders. Sykes says large rings of the same people run promotions using different press releases and companies, including the reappearance of a notorious stock manipulator who was first convicted for an email pump-and-dump scheme when he was in high school.
Leave shorting penny stocks to the pros. Stick with stocks that trade at least , shares a day. If you trade stocks with low volume, it could be difficult to get out of your position.
He also suggests that you trade penny stocks that are priced at more than 50 cents a share. Although it takes more concentration, use mental stops. I aim for or , but not or If I think a dollar stock has only cents upside , my mental stop loss will be at 10 cents because the risk-reward is better.
Every penny stock company wants you think it has an exciting story that will revolutionize the world.
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