The term “penny stock” is most commonly used to refer to stocks of companies with very small market capitalizations that trade on The Over the Counter Bulletin Board or the Pink sheets, although technically it can cover any stock under $5 per share.
In the U.S. financial markets, the term penny stock commonly refers to any stock trading outside one of the major exchanges (NYSE, NASDAQ, or AMEX), and is often considered pejorative. However, the official SEC definition of a penny stock is a “low-priced, speculative security of a very small company, regardless of market capitalization or whether it trades on a securitized exchange (like NYSE or NASDAQ) or an “over the counter” listing service, such as the OTCBB or Pink Sheets.” The terms penny stock, microcap stock, small caps, and nano caps are sometimes all used interchangeably, however per the SEC definition, penny stock status is determined by share price, not market capitalization or listing service.
The Securities and Exchange Commission has special broker requirements for penny stocks, including the requirement that brokers who wish to offer penny stocks to their clients must give special warning to them of the danger of investing in penny stocks
Penny stocks are not typically covered by Wall Street analysts or mentioned in business media.
Penny stocks are risky investments, and for good reason. They typically are thinly regulated, have to meet less rigorous listing requirements, and can be very illiquid.
Penny stocks are often relentlessly promoted as part of illegal pump and dump schemes. This scam works by popularizing a stock so that demand goes up, the price goes up, and then all efforts at holding the price up are halted and the stock price crashes.
“A company’s web site may feature a glowing press release about its financial health or some new product or innovation. Newsletters that purport to offer unbiased recommendations may suddenly tout the company as the latest “hot” stock. Or you may even hear the company mentioned by a radio or TV analyst. Unwitting investors then purchase the stock in droves, creating high demand and pumping up the price. But when the fraudsters behind the scheme sell their shares at the peak and stop hyping the stock, the price plummets, and investors lose their money. Fraudsters frequently use this ploy with small, thinly traded companies because it’s easier to manipulate a stock when there’s little or no information available about the company.”
A more recent outbreak of penny stock fraud is based mostly overseas. Organized crime gangs in Eastern Europe and Asia will acquire a large number of shares of a moribund penny stock.
Then, using passwords and logins to electronic brokerages, such as E*Trade, stolen at public computer terminals in hotels and elsewhere, they will then use the hijacked customer accounts to buy up shares, while at the same time selling their own shares, draining the customer accounts and leaving their victims holding thousands of shares of worthless penny stocks.
While not all stocks listed on the OTCBB or the Pink Sheets are fraudulent, one Business Week article estimated that chop stocks alone “make up perhaps half the 85 million-share daily volume of the OTC Bulletin Board.
Many new investors are lured to the appeal of a penny stock due to the low price and potential for rapid growth which may be as high as several hundred percent in a few days. Similarly, severe loss can occur and many penny stocks lose all of their value in the long term. Accordingly, the SEC warns that penny stocks are high risk investments and new investors should be aware of the risks involved. These risks include limited liquidity, lack of financial reporting, and fraud
By: Adma Dababneh
some information is taken from Wikinvest.com
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