The Problem With Trading Penny Stocks

This is an article I would like to share. It gives an interesting perspective of the penny stock market.



There is a perception that one way to “make it big,” or get-rich-quick is by trading penny stocks. From the onset, I would like to state that I do not feel comfortable trading these stocks. Further, any scheme that promises quick wealth is suspect. There has been a proliferation, of late, of brokerages and other similar type firms trumpeting the potential profits in the penny stock market(sometimes called the micro-cap market). As a longtime trader, I have an intimate knowledge of the inner workings of these stocks and shy away from them at all costs.

That’s a fairly radical statement. Why would I say such a thing?

The term “penny stock” is nebulous, at best. Many people consider stocks that trade on the NASDAQ Smallcap Market penny stocks. Generally speaking though, stocks traded on this exchange sell for more than .00 per share and are subject to reasonably strict reporting requirements in order to stay listed on this exchange. Further, if shares in a stock fall below a dollar they are usually booted off the exchange. In essence, there is some transparency for traders to evaluate when analyzing stocks on the NASDAQ Smallcap Market. As an added bonus, some of these stocks have decent volume which enables even greater market visibility. I don’t think it’s fair to characterize stocks on this exchange as true micro-cap stocks, as most sell between .00-.00 and are subject to stringent reporting requirements.

In my opinion, any stock that sells on the OTC Bulletin Board and the Pink Sheets qualifies as a penny stock.

Some micro-cap stocks (the stocks that trade for under .00) can be found on the OTC Bulletin Board. Getting audited financial information about firms on the OTC Bulletin Board can be difficult if not impossible. In a nutshell, the OTC Bulletin Board provides quotes, price data, and buy-sell information. Stocks listed on this exchange are not required to provide audited financial reports and evaluating these companies is difficult, if not impossible.

You will find even more of the penny stocks trading on the Pink Sheets. Stocks on the Pink Sheets are subject to absolutely no reporting requirements and there is no regulation in their trading. Further, there is no listing requirement for this exchange. The Pink Sheets is, at best, a three ring circus full of stocks that may or may not be of dubious value.

There are some success stories trading these stocks, and honest and unbiased information can be had from the right sources. A small number of true “experts” exist in this industry. However, the vast majority of experts are often firms who specialize in publicizing micro-cap stock issues. These firms are paid in a number of ways, usually in shares of the stock. So, it is in their best interest to generate interest, through any means possible, and cause the price to rise. Usually these firms recommend the stock through various media outlets like financial television, radio programming and e-mail spamming. The information from these firms is generally spurious and of questionable value.

And that is where the real problem starts when trading penny stocks, who do you believe? The number of financial newsletters pumping penny stocks on the Internet seems to be at all time high and it is difficult to get full disclosure as to any financial remuneration the firms may reap as a result of their stock recommendation. In preparing to write this article, I did some basic research by calling a penny stock broker advertised on the internet and listened to his spiel regarding a stock in the medical field. At the conclusion of the talk, I asked him if his firm was receiving compensation of any kind to promote this issue, and our cheerful conversation turned rather dark. He finally told me that since the stock is traded on the Pink Sheets they were not required to disclose information of that nature.
There are four important problems to consider when considering penny stocks:

1. It is very difficult to get pertinent information about the products and financial standing of most stocks.
2. Especially on the pink sheets, there are no requirements for obtaining a listing. I am aware of several instances in which pink sheet registered stock offerings did not even have a product to offer the public. They were simply shell companies.
3. Most companies that fall into the micro-cap stock category have little history for you to examine.
4. Since many of these penny stocks are very thinly traded, there may be no market in the stock or, at a very minimum, a wide bid ask spread to contend with to sell the stock.

Many people buy these stocks hoping to find the next Microsoft lolling around the OTC Bulletin Board. Microsoft was never on the Pink Sheets, or the OTC Bulletin Board. It opened on the NASDAQ for . Most companies with tremendous profit potential are issued through an IPO and never hit the penny stock market. That is an important fact to keep in mind.

In summary, penny stocks are a very risky venture and the failure rate in these firms is astronomical. If you must trade penny stocks I recommend seeking out an honest and reputable firm to work with your investment. My experience is that honest and reputable firms in the penny stock market are far and few between.

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