Why penny stocks can turn out to be an expensive purchase: Internet Scambusters #1,089
Buying penny stocks is a high-risk investment. Yes, you could make a hefty profit, but the odds are against you.
And that's before scammers step in to trick you by luring you in to push up the price and then dumping their own holdings before the price collapses.
We'll explain the most common penny stock scams and how you can avoid them in this week's issue.
Let's get started…
Penny Stock Scams: How They Work And How To Avoid Them
There's big money to be made from trading penny stocks. But a lot of it is by scammers. And there's no shortage of potential victims.
Every year, investors hunting get-rich-quick opportunities, lose millions of dollars buying and selling penny stocks - actually called micro-cap stocks and referring to equities selling for under $5 apiece.
They're risky at the best of times but the lure can be overwhelming. Why? Simply because if you bought one for literally one cent and the price went up to two cents, you made 100 percent profit.
The bad news is that this rarely happens. And if it does, it was likely a scammer who paid the one cent and you, the investor, who paid two. That may be okay if you only bought a few, but gullible investors may buy many, many thousands after being tricked into thinking the price would continue to rise.
And when they try to bail out, to cut their losses, they usually can't find anyone who wants to buy them. So, they end up losing every single cent they plowed in.
The root of the trouble is that trading these cheap equities on what are known as over-the-counter (OTC) markets is not nearly as tightly controlled as regular stocks are on the likes of NASDAQ and the New York Stock exchange.
That leaves the way open for a variety of schemes, mostly lies or lack of information about the activities of the companies behind the stocks.
For example, Cynk Technology was a penny stock that soared over 25,000% in 2014 despite having no assets, revenues, or operations. The lack of financial information on the company made it impossible for investors to know whether the price was justified. The stock eventually crashed back down over 99% from its peak.
Then, there was the famous case of Jordan Belfort, on whom the movie Wolf of Wall Street was based, which cost investors $194 million.
Common Penny Stock Scams
The two most common scams relating to penny stocks are:
- Lack of financial information, as in the Cynk Technology case we just mentioned. Unlike larger, publicly-traded companies, penny stock companies are not required to file detailed financial statements with securities regulators.
- Price manipulation, more commonly known as pump and dump schemes. As we know, fake news is easier than ever to create and spread. Scammers repeatedly talk up the prospects for a company after buying its stocks from the bottom of the price barrel. Investors pile in as the price soars, then the crooks sell their holding.
Often, fraudsters use high-pressure sales tactics, calling potential victims and spinning a web of lies to try to talk them into buying. These characters operate from offices termed "boiler rooms," repeatedly calling their targets and implying they'd be stupid not to buy their stocks.
They also spam their potential victims, sending out multiple emails every day. Or they may issue legitimate looking newsletters and posts on social media.
Large-scale scammers even employ and pay people to spread their lies.
How to Avoid Penny Stock Scams
It's probably fair to say that the lower the price of a penny stock, the greater the potential for a big fat profit - but more likely a big fat loss.
Don't let that happen to you by taking the following steps:
- Thoroughly research any company you're thinking of investing in. If big chunks of information are missing, that's a red flag. Check for proper licenses/registrations and look on consumer protection websites for alerts. Verify growth claims.
- Another red flag: promises of guaranteed high returns with little or no risk. All investments carry risk.
- Only invest in companies with audited financial statements from reputable firms. Be wary of one-person audit shops.
- Ignore paid stock ads and sponsored content. Focus investment decisions on company fundamentals rather than ads.
- Hang up on boiler room operators. You'll know them when you hear them, They make unsolicited calls to push specific stocks and often claim they have valuable inside information.
- Be skeptical of unconfirmed news reports of market-moving activities. Be especially wary of newly launched financial websites.
- Don't be influenced by "friends," message board acquaintances, and family members claiming they're in on a good penny stock deal. Still do your research.
- Don't provide any personal financial information to someone you don't know and don't fully trust.
- Beware of statements saying a stock has been checked and approved by the US Financial Industry Regulatory Authority (FINRA). They don't do that.
- Learn more by visiting their website, which also has a searchable database of legitimate stockbrokers.
Finally, and importantly, take advice from a trusted financial professional before making any investment decisions. Scambusters does not provide financial advice. The less you know about a stock, the higher the risk you'll lose money. Most likely, professional advisers will steer you away from penny stocks.
This Week's Alert
War victims: The conflict between Israel and Gaza has led to death or injury for many thousands of innocent civilians on both sides. You can be sure scammers are exploiting this by setting up phony charities and online funding pleas for victims. Be on your guard and preferably donate to known, recognized charities.
That's all for today -- we'll see you next week.