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Navigating the Dangerous World of Penny Stocks

Many traders and investors want action, and unfortunately many stocks that are commonly traded in the stock market do not move very quickly. Thus, many traders in search of market volatility and action are enticed into trading what are called “Penny Stocks.” Penny stocks refer to shares in a company which trade for less than $5.00, but many penny stock traders focus on companies that are trading for less than $1 per share and even as low as fractions of $0.01 per share. Oftentimes these companies have market capitalization of less than $50 million.

Traders are drawn to penny stocks for several reasons, but the primary reason is the possibility of making lots of money very quickly. First of all, penny stocks tend to be very volatile with large and sharp price movements in a relatively short amount of time. Large stocks such as Google and Microsoft may move around 1% on a normal day whereas a penny stock can up and move over 100% in a single day! These huge price swings offer the potential for large gains for traders and investors in a short amount of time.

Second of all, penny stocks tend to have much greater upside potential on a percentage basis. A large cap stock does not have the potential, generally, to increase 10 fold over the course of several months or even years. Penny stocks, however, have huge upside potential. Third of all, penny stocks are much easier to acquire with less initial investment, which is why many traders are drawn to them. Significant positions can be built up for a few hundred or thousand dollars. There are major risks inherent in trading and investing in general, and penny stocks are viewed as some of the highest risk investments a trader can make. One reason penny stocks tend to be much riskier than larger cap stocks is because they are much more subject to fraudulent activities.

Pump & Dump
This is a common fraudulent activity that unfortunately transpires in the penny stock world. First, an individual or organization, or even the company itself, will purchase huge amounts of a penny stock. Once the position is taken, the fraudulent party will then begin to hype the company through a number of avenues. They may use websites, fake press releases, or e-mail blasts to drive interest in the company. This would the “marketing campaign.” Reputable brokers or forex brokers do not usually engage in this type of behavior.

During this phase of the fraud, the fraudulent party will do anything it can to raise interest in the company, but the primary tactic is to simply spread as much false, hyped up information as possible. Eventually, people start to buy the penny stock. Then, as the stock price rises high enough, the fraudulent party will sell all of its stock and cash out with millions of dollars and all of the new investors will be left with huge losses. The company is generally in very poor condition, if it is real at all, and there is no way for the stock to recover. Thus, the investors who fall prey to this fraud will never get their initial investments back.

Offshore Accounts
There are several variations of this type of scam, but typically a company will set-up entities outside of the United States and then trade shares back and forth, which gives the illusion that there is heavy trading volume in the stock. This apparent heavy trading volume eventually catches the attention of traders and investors and people start buying the stock. Eventually, when the price is high enough, the company will dump all of its stock and cash out with large profits, while traders and investors will lose all or most of their money.

There are also many a forex scam that take place in the foreign-exchange market. The easiest way to avoid fraud in the penny stock world is to simply invest only in companies that provide in-depth verifiable company financials. Never trust a report unless you can verify it beyond a shadow of a doubt.
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