To give you an overview on what penny stock is, other than being sold in less than a dollar, let’s start with the general term. Stock or equity is simply a share in the ownership of the company in terms of its assets and its earnings. The management of the company is responsible for the day-to-day operations in order to increase the value of the company; hence your share. The same concept revolves around penny stocks but many find this more interesting and at the same time, controversial. Unlike stocks traded in several exchange market like in Wall Street in New York, penny stocks or microcap stocks has low market capitalization. It lacks liquidity, not traded in national stock exchanges, and can be highly manipulated. The idea of spending a small amount of money in penny stocks and yielding a huge profit is promising and speculative as well. But how can you maximize the opportunity of earning while minimizing the risks of losing? Well, it is all about being well-informed of the threats in trading penny stock. One of the common microcap stock fraud that you need to cautious of is pump and dump scheme.
In pump and dump scheme, a stock promoter or marketer falsely makes hype on a particular stock by sending spam emails claiming that they have inside information of which stocks will increase its value. Prior to internet, the promoters use telemarketing to attract potential investors. Once this information reach investors and they are enticed to purchase the stocks, the promoters are then successful in artificially “pump” up the stock value. With the increasing price, mixed with continuous marketing schemes, the demand for the stocks increases, the price inflates tremendously and more investors join the bandwagon. Then after a period of time, the promoters of the scheme sell or “dump” their shares and stop their marketing efforts. The price of stock goes haywire until it plummets. When this happens the shareholders, mostly out of panic, will sell their stock in a lower price, hence losing their investment.
With this kind of ploy, selling fraudulent microcap stock goes under the radar since the companies involved are thinly traded and poorly regulated. Manipulation of prices is highly possible when there is limited independent and unbiased information. A spin-off of pump and dump is hack, pump and dump. In this scheme, a person buys penny stocks in large volume with the use of compromised brokerage accounts. The result is inflation in the price of the stocks and then the holder sells his share at a premium. The end result is again, investors losing their money.