Types of Penny Stock Fraud

| April 10, 2012 | 0 Comments

While the definition of “penny stock” has not been established with completely certainty and accuracy by anyone, penny stocks do tend to have certain defining characteristics. Most of the time, they trade below $5 per share, although not every stock with a price this low can be considered a penny stock. They also tend to have a small total value of shares on the market, known as market capitalization. Finally, penny stocks tend to not be readily liquid, or easy to buy and sell. This is partly due to the small market capitalization.

Although investing penny stocks can occasionally be a source of tremendous income over a short amount of time, this is not guaranteed or even the most likely outcome. In order to know which penny stocks to buy it’s important to be aware of three major types of fraud involved in this sector of the market.

The first type is called pump-and-dump. A company owner or shareholder with a significant interest in the company will buy a huge number of shares, often chronologically coinciding with a positive press release justifying such an action. This creates artificial demand (the pump), which increases the price. The initial shareholder rides the price up and then sells all shares (the dump). Investors realize the stock was overvalued, and attempt to sell out, but because of low liquidity and pure inability to act fast enough, some will lose everything.

The second type of scam strategy works exactly in reverse as a pump-and-dump. Instead of hype, the investor will short a huge number of stocks in conjunction with spreading a rumor of the company’s demise. The price will fall dramatically as investors scramble to get rid of a plummeting stock. When the truth that the reason for panic was simply a rumor comes out, the initial investor will buy to cover the shorted shares.

A third type of fraud is called insider trading. This method is actually illegal. It involves buying shares prior to the release of information of a company’s profits. When the information is released, other investors realize the increase value of the company and get on board, sending the price of shares up.


Category: Penny Stock Tips

About the Author ()