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Last Post: 8/29/2016 10:42:43 AM - Followers: 10 - Board type: Free - Posts Today: 0
Successful companies aren't born, they're made and they have to work their way from humble beginnings and through the ranks just like everyone else. Unfortunately, some investors believe that finding the next "big thing" means scouring through penny stocks in the hope of finding the next Microsoft or Wal-Mart. Unfortunately, this strategy will prove to be unsuccessful in most cases. Read on to find out why pinning your hopes on penny stocks could leave you penniless.

SEE: How To Evaluate A Micro-Cap Company

Penny Stocks 101
The terms "penny stocks" and "micro-cap stocks" can be used interchangeably. Technically, micro-cap stocks are classified as such based on their market capitalizations, while penny stocks are looked at in terms of their price. Definitions vary, but in general, a stock with a market capitalization between $50 and $300 million is a micro cap. (Less than $50 million is a nano-cap.) According to the Securities & Exchange Commission (SEC), any stock under $5 is a penny stock. Again, definitions can vary; some set the cut-off point at $3, while others consider only those stocks trading at less than $1 to be a penny stock. We consider any stock that is trading on the pink sheets or over-the-counter bulletin board (OTCBB) to be a penny stock.

The main thing you have to know about penny/micro stocks is that they are much riskier than regular stocks.

A Fortune for a Penny?
What makes penny stocks risky? Four major factors make these securities riskier than blue chip stocks.

1. Lack of Information Available to the Public
The key to any successful investment strategy is acquiring enough tangible information to make informed decisions. For micro-cap stocks, information is much more difficult to find. Companies listed on the pink sheets are not required to file with the Securities and Exchange Commission (SEC) and are thus not as publicly scrutinized or regulated as the stocks represented on the New York Stock Exchange and the Nasdaq. Furthermore, much of the information available about micro-cap stocks is not from credible sources.

2. No Minimum Standards
Stocks on the OTCBB and pink sheets do not have to fulfill minimum standard requirements to remain on the exchange. Sometimes, this is why the stock is on one of these exchanges. Once a company can no longer maintain its position on one of the major exchanges, the company moves to one of these smaller exchanges. While the OTCBB does require companies to file timely documents with the SEC, the pink sheets have no such requirement. Minimum standards act as a safety cushion for some investors and as a benchmark for some companies.

3. Lack of History
Many of the companies considered to be micro-cap stocks are either newly formed or approaching bankruptcy. These companies will generally have poor track records or none at all. As you can imagine, this lack of historical information makes it difficult to determine a stock's potential.

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4. Liquidity
When stocks don't have much liquidity, two problems arise: first, there is the possibility that you won't be able to sell the stock. If there is a low level of liquidity, it may be hard to find a buyer for a particular stock, and you may be required to lower your price until it is considered attractive to another buyer. Second, low liquidity levels provide opportunities for some traders to manipulate stock prices, which is done in many different ways - the easiest is to buy large amounts of stock, hype it up and then sell it after other investors find it attractive (also known as pump and dump).

Penny-Baited Traps
Penny stocks have been a thorn in the side of the SEC for some time because lack of available information and poor liquidity make micro-cap stocks an easy target for fraudsters. There are many scams used to separate investors from their money. The most common include:

Biased Recommendations
Some micro-cap companies pay individuals to recommend the company stock in different media, such as newsletters, financial television and radio shows. You may receive spam email trying to persuade you to purchase particular stock. All emails, postings and recommendations of that kind should be taken with a grain of salt. Look to see if the issuers of the recommendations are being paid for their services as this is a giveaway of a bad investment. Also, make sure that any press releases aren't given falsely by people looking to influence the price of a stock.

Offshore Brokers
Under regulation S, the SEC permits companies selling stock outside the U.S. to foreign investors to be exempt from registering stock. These companies will typically sell the stock at a discount to offshore brokers who, in turn, sell them back to U.S. investors for a substantial profit. By cold calling a list of potential investors (investors with enough money to buy a particular stock) and providing attractive information, these dishonest brokers will use high-pressure "boiler room" sales tactics to persuade investors to purchase stock.

SEE:What is a boiler room operation?

The Penny Stock Fallacy
Two common fallacies pertaining to penny stocks are that many of today's stocks were once penny stocks and that there is a positive correlation between the number of stocks a person owns and his or her returns.

Investors who have fallen into the trap of the first fallacy believe Wal-Mart, Microsoft and many other large companies were once penny stocks that have appreciated to high dollar values. Many investors make this mistake because they are looking at the "adjusted stock price," which takes into account all stock splits. By taking a look at both Microsoft and Wal-Mart, you can see that the respective prices on their first days of trading were $21 and $16.50, even though the prices adjusted for splits was about eight cents and one cent, respectively. Rather than starting at a low market price, these companies actually started high, continually rising until they needed to be split.

The second reason that many investors may be attracted to penny stocks is the notion that there is more room for appreciation and more opportunity to own more stock. If a stock is at 10 cents and rises by five cents, you will have made a 50% return. This, together with the fact that a $1,000 investment can buy 10,000 shares, convinces investors that micro-cap stocks are a rapid, surefire way to increase profits. Unfortunately, people tend to see only the upside of penny stocks, while forgetting about the downside. A ten cent stock can just as easily go down by five cents and lose half its value. Most often, these stocks do not succeed, and there is a high probability that you will lose your entire investment.

The Bottom Line
Sure, some companies on the OTCBB and pink sheets might be good quality, and many OTCBB companies are working extremely hard to make their way up to the more reputable Nasdaq and NYSE. However, there are good stock opportunities out there that aren't trading for pennies. Penny stocks aren't a lost cause, but they are very high-risk investments that aren't suitable for all investors. If you can't resist the lure of micro caps, make sure you do extensive research and understand what you are getting into.
#87  Sticky Note *I would suggest if you post a ticker, StockFalcon 08/25/13 12:59:23 PM
#288   NPWZ Neah Power News in a Company Tweet ShortonCash 08/29/16 10:42:43 AM
#287   PRVT 1 penny breakout from sub penny trading. readycapital 02/05/16 06:28:53 AM
#286   I like the technical trading pattern I see Spacely 02/04/16 01:55:03 PM
#284   PAOC is on a roll!! UP 3.60(180.00%) gradystocks 12/17/14 05:15:08 PM
#283   PAOC the spread is a little on the gradystocks 12/17/14 11:18:31 AM
#282   $MSMY - BREAKOUT! riskon 12/16/14 02:56:54 PM
#281   PAOC has a low float...getting ready to see gradystocks 12/16/14 01:22:13 PM
#280   NDEV UP 105.88% DFDBTB 12/11/14 01:29:25 PM
#279   FOYJ..Only PROFITS Here at triple zero one reel 11/30/14 07:42:41 PM
#277   MDIN, last chance to get in at entry! Optimus Prime28 06/19/14 05:26:20 PM
#276   EXSL EXSL EXSL Pennynutz 05/06/14 05:30:19 AM
#275   Beaus Ruby Visit ReCap Wednesday, 11/06/13 04:56:48 AM Re: None Post Spanky227 11/11/13 09:13:51 AM
#274   We found out yesterday workers at the Ruby Spanky227 11/09/13 04:42:42 PM
#273   YIPI now current. Prep for fortune 100 buyout. buckyeffindent 10/30/13 05:37:16 AM
#272   $CCTC ~ Overview: Company Penny Roger$ 10/16/13 06:46:01 PM
#271   IDGC heavy churn today. Something coming looking for JerseyDrew 10/10/13 04:25:53 PM
#270   $TGGI- HIGH VOLUME 4 days in a row! SIRIUS 10/10/13 02:29:31 PM
#269   NBRI today is the day!!! Spanky227 10/10/13 08:10:16 AM
#265   $TGGI- NEWS BREAK! SIRIUS 10/04/13 02:42:01 PM
#264   $TGGI-REDUCED A/S FROM 5 billion to 3.6 BILLION!! SIRIUS 10/04/13 12:48:25 PM
#263   Good day to pick up the final cheap Spanky227 10/04/13 06:48:24 AM
#262   LVGI G.E.A.R New CEO( Link ) don't wait legaltips 10/03/13 11:13:43 PM
#261   $pcfg merger news . Load up now , SeePalms 10/02/13 07:05:07 AM
#260   $EPGG ~ Announced that its newest patent pending Penny Roger$ 10/01/13 07:28:58 AM
#259   AEGY = Undervalued at .001?? I'll leave Inhibiton 09/29/13 11:18:46 PM
#258   $OWOO 20 bagger here Penny_God 09/27/13 10:30:51 AM
#257   $OWOO .004 getting ready to run big Penny_God 09/26/13 09:03:09 PM
#256   NBRI first gold mined in company history this Spanky227 09/22/13 04:17:12 PM
#255   $FNMA long here $1.31 Penny_God 09/22/13 12:53:27 PM
#254   DUTV and SLIO both look primed for a JerseyDrew 09/18/13 06:50:24 AM
#253   $iliv huge things coming for this start up . SeePalms 09/18/13 06:24:29 AM
#252   $ASTM .305 getting ready to breakout huge Penny_God 09/17/13 04:07:20 PM
#251   $iliv life changer . Extremely undervalued! SeePalms 09/16/13 09:24:59 AM
#250   perfect trifecta for IFUS TO BUY Monday PEACHMAN 09/14/13 10:02:50 AM
#249   I agreee 100%! I cant wait for IFUS Tstorm 09/14/13 09:19:58 AM
#248   IFUS CUPBOARD COMBINED WITH NEW PR makes me PEACHMAN 09/14/13 06:48:56 AM
#247   IFUS bull flag breakout! Chart here, check it Tstorm 09/13/13 10:09:38 PM
#246   Nice to see TDEY moving big here. Need Diversified 09/13/13 11:02:30 AM
#245   TDEY +50% BIG MOVE COMING!! lee13 09/13/13 11:01:49 AM
#244   You gotta see this a stock shorted so legaltips 09/13/13 03:00:53 AM
#243   $ILIV-NEWS IS OUT! EASY 3-5 BAGGA! SIRIUS 09/12/13 08:57:34 AM
#242   YIPI has a 100% buy rating (see below) TenTimesPay 09/12/13 01:51:16 AM
#241   DSCR$$$ cjstocksup 09/12/13 12:06:25 AM
#240   $DSCR .0005 super hot alert! Penny_God 09/11/13 08:10:12 PM
#239   Also check out $MYEC- another bull reversal is happening? SIRIUS 09/11/13 12:16:04 PM
#238   $KGRI- nice momo play! Accumulation happening! Explosion can SIRIUS 09/11/13 12:15:44 PM
#237   I'll check it out Penny_God 09/10/13 11:28:22 PM