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Concern areas for trading/investing in penny stocks:
Lacking the stringent regulatory requirements, Penny stocks may not be
listed on national exchanges – a clear indication of the high risks
associated with penny stocks.
Trading occurs on smaller exchanges (like OTCBB and Pink Sheets) which may
not have requirements of returns filing and open information sharing,
keeping investors unaware of the company’s business and prospects
Short term highly volatile price variations, combined with long dormant
periods of low prices, makes it difficult for common investors to assess the
investment potential
High speculations, limited information, low liquidity, high bid-ask spread
prices and trading dominated by select market-makers
Highly prone to manipulation by market participants and promoters leading
rise to possibility of scam (discussed below).
Promotions playing on ignorant and uninformed investors' greed who are lured
by low prices and unrealistic expectations of high returns, which may not
materialize even after a long duration.
The role of the penny stock broker:
Stock brokers play a vital role in the trading business. Apart from their
facilitator role in providing the necessary trading infrastructure, stock
brokers can significantly influence the preferences, behavior and trading
patterns of common investors through their other functions of
recommendations, sales and marketing.
Considering the above mentioned concern areas and high risks associated with
penny stocks, the case of penny stock brokers (and their roles) becomes
more interesting. It's highly important to select the right broker for
highly speculative investments like penny stocks. A lot of brokerage houses
operate in this space – SureTrader, ChoiceTrade, Zecco, TDAmeritrade (AMTD)
, E-Trade (ETFC), Scottrade, Tradeking, etc – to name a few.
Penny stock scams (and how to avoid the pitfalls):
Anything that appears to offer high returns with low costs has as scam
potential. Certain typical red flags each investor should be aware of:
Heavy unofficial promotions through internet/emails
Promotions through brokers' boiler room telemarketing calls instead of open
and fair marketing
Claims about insider information leading to a penny stock being the multi-
bagger
Vaguely labeled newsletter and online forums filled with lots of “
recommendations”
Common traps that penny stock investors should be aware of are:
Pump & Dump schemes: Promoters claiming access to “insider information” to
inflate the prices, but in reality may be attempting to offload the earlier
purchased low-cost lot at high profits. The investors who act on these tips
may end up sitting with high cost investments.
Short and Distort: Another variant of pump and dump, working in the reverse
direction. Promoters short sell the penny stock at a high price and then
promote negative news about the stock to lower the price and square off
their positions for a big profit.
Long term averaging techniques: A cyclic scheme, where investors are advised
to keep on accumulating a penny stock with each price dip, with assurances
of windfall profits once the stock prices take a positive turn.
Recommendations from brokers play a key role in such schemes.
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