Explanation of Penny Shares, How they trade and how they are manipulated in the market.

What they are...

Penny stocks cost relatively little per share, hence the name. Most penny stocks are shares of small companies that usually do not have great market saturation. Information on companies selling this type of share can be hard to find. Penny shares work the same way as any other stock: An investor buys shares and hopes that the interest in the company will grow, increasing the value of his stake and then he sells his shares and makes a profit.

The main difference between penny shares and stocks, such as those listed on the FTSE 100 is that penny stocks can have enormous daily variances and can offer a potentially huge reward, but at the cost of an equally huge risk.

The lower the price of the stock the greater this risk: as an example, if a stock only costs 10 pence per share, an increase of 1 penny would be 10%, a return that many would consider very good. The downside is that if the price falls by a penny, the stock declines just as quickly.

How they trade...

Penny stocks are usually traded over the counter (OTC) rather than on markets such as the Stock Exchange, where there is more control and transparency. The major difference is that OTC securities are unlisted, so there is no central exchange for the market. It is easier to manipulate a stock when there is little or no independent information available about a company. In the UK, penny shares are typically associated with small companies on the AIM or OFEX - new companies with no track record; many of them have never made a profit and never will.

How they can be manipulated in the market...

In the past would-be scammers had to rely on cold calling or passing information by the person in the pub who knows everything there is about money matters! Nowadays, the internet offers an easier way of reaching large numbers of potential investors. This can be done through email scams, which promise amazing returns, fake press releases in which good (but false) news is spread, or through telemarketing from "boiler room" brokerage houses who claim to have "inside" information about “hot" stock. These Pump and Dump schemes urge the reader to buy the stock quickly.

Unwitting investors then purchase the stock, creating high demand, which raises the price. This seemingly "real" rise can entice more people to buy shares as well. Once the operators of the scheme "dump" their overvalued shares, making a profit, the price falls back down and investors lose their money. This process is illegal, but extraordinarily difficult to prosecute.

Warning...

Investing in penny stocks, no matter how skilled the investor, can be a boom or bust experience similar to the lure of a slot machine and should only be undertaken with caution. Follow one simple rule: Never gamble on stock and never invest money you cannot afford to lose.

date added: 08/02/2013

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