Penny stocks are stocks that sell for $5 or less, and in many cases you're lucky if they're worth even that much. Most penny stocks usually have no substantial income or revenue. You have a high potential for loss with penny stocks. If you have a strong urge to invest in this type of company, take time out to follow the stock to see if it has made any headway. Learn all you can about the company, and don't be tempted to act on a hot tip that may have been passed your way.
Penny stocks trade in either the pink sheets, a forum operated by the National Quotations Bureau, or on the NASDAQ small-cap market. Pink sheets, in brief, are listings and price information literally printed on pink sheets of paper that go to select brokers.
The companies behind these stocks are thinly capitalized and are often not required to file reports with the SEC. They trade over the counter, and there is a limited amount of public information available. This in itself is reason for concern. How many astute investors want to put their money into an investment offering little or no information? Nonetheless, people do invest in these stocks.
One of the most interesting — and alarming — aspects of penny stock dealing is that brokers are not always acting as a third party but instead set prices and act as the principals in the transaction. Penny stocks most often do not have a single price but a number of different prices at which they can be purchased or sold.
Okay, so there's little information about the company, the price, or anything else to investigate. But the guy on the phone — making a cold call — says it will be the next Starbucks! This is where they get you. Thanks to the Internet and the selling of phone lists, penny stocks dealers can reach out far and wide. They use high-pressure sales tactics and armies of callers to tell you anything to make you buy the stocks. Beware!
Unscrupulous brokers often hype and promote companies that have minimal assets. With these “pump and dump” schemes, hard-selling wheeler-dealers hype the stocks, making outrageous claims about the company that are wholly unsubstantiated by the facts. They drive up the share price so that they can cash in on artificial price inflation for a company that is worth nearly nothing!
All of this is not to say that there are no low-priced legitimate stocks on the market. There are. They are usually small grassroots companies that can grow over time — if you pick the right one and wait a while. You should invest cautiously and conservatively at first. Look for a new company with good leadership in an industry where you see growth potential. It's also advantageous to find a company that holds the patent on a new product. If the product takes off, so could your stock. You must seek out all of this information — it will not come to you via a cold caller.