Detecting Penny Stock Scams

| April 3, 2012 | 0 Comments

Penny stocks can be a volatile way to make money. While volatility is often seen as a bad thing when investing, many investors take advantage of volatility to make money faster than with a buy and hold strategy. Buy and hold is a safe way to make money, but, when investing in the stock market, the general principle of increasing risk to increase profits applies.

Penny stocks are risky. With the risk comes the potential for enormous gains, and these gains are what scammers focus on when pushing their investing plans on prospective investors. To determine whether a broker is a scammer, itÂ’s important to know what a scam looks like so that you can identify one when it comes along.

Penny stocks generally trade under very small volumes. Often a person will be able to invest enough into a stock to actually influence its price directly, through the principle of supply and demand. Furthermore, a penny stock usually trades on a small enough market that there will be almost no buyers. So how does this play out in a scam scenario?

These scams are called pump-and-dump schemes, and work by the owner of a company manipulating the price of a stock at the investorsÂ’ expense. First, the scammer/owner will offer its shares for public trading. Then, it will release news speculating a sharp rise in productivity, price and profits. Next, by buying up a large fraction of its own stock, the company can actually drive the price up (as supply goes down, price rises). Usually during this stage, the company will aggressively convince small time investors that this is one of the best penny stocks to buy, stressing the sharp rise of the stock. As more people get on board, the stock goes even higher. But, the company finally dumps their entire share. With so many more shares on the market, the stock begins to drop. As it drops, more investors bail out, sending it plummeting. Often the stock goes to zero and never recovers.

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Category: Pump & Dump Alerts

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