A friend found this on the internet and thought it might help some of you better understand how these penny stocks work. Just keep in mind there are so many variables these rules are not set in stone but it is a good starting point! I hope this helps..
WHAT ARE PENNY STOCKS?
There is no set, accepted definition of penny stock. Some people define it
as stock priced under one dollar, some under five dollars. Some people
include only those securities traded in the "pink sheets," some include
the entire OTC market. The Securities Division considers a stock to be a
"penny stock" if it trades at or under $5.00 per share and trades in
either the "pink sheets" or on NASDAQ. In addition, a true penny stock
will have less than $4 million in net tangible assets and will not have a
significant operating history. (In other words, if a company has real
assets, such as equipment and inventory, and is engaged in some real
business, such as manufacturing, then the Division does not consider the
stock to be penny stock even though the shares are low-priced.)
The "OTC" market
Penny stocks are not traded on a stock exchange, but are traded in the
over-the-counter (OTC) market. Part of the OTC market is the National
Market System (NMS) of the NASDAQ (National Association of Securities
Dealers Automated Quotation) System, which does not include any penny
stocks.
There are also non-NMS NASDAQ securities, including some penny stocks. The
NASDAQ system has listing standards that change from time to time and,
depending on the standards, there may be more or fewer penny stocks on
NASDAQ. If you purchase a low-priced security that is listed on NASDAQ, it
will meet certain minimum standards. In addition, many NASDAQ prices are
quoted regularly in newspapers, allowing you to follow the price of your
security instead of forcing you to rely on your broker for all price
information.
The third major component of the OTC market is the National Quotation
Bureau's (NQB) service, commonly referred to as the "pink sheets." The
NQB's securities lists and price information, printed on pads of long,
narrow sheets of pink paper, have, for all practical purposes, no
meaningful listing standards, and price information is sometimes
difficult, if not impossible, for the small investor to obtain.
Broker-dealers obtain their price information by calling the trading desks
of three "market makers." Obviously, small investors do not have access
to those traders and must rely on their stockbroker for accurate price
information.(Editorial Note: right now, investors can get this free
information via the Internet)
Principal/Agency
In most securities transactions, your broker-dealer acts as your agent,
arranging a transaction directly between you and a third party. In
compensation for arranging that trade, you pay your broker-dealer a
commission. In some instances, the broker-dealer has the security you seek
to purchase in inventory, or wants the security you wish to sell. The
broker-dealer may trade with you on its own behalf, as a principal in the
transaction. When the broker-dealer acts as a principal, and not as an
agent, the trade confirmation should say that on its face. The
broker-dealer is not paid a commission in principal trades, but makes its
money on the spread, and by buying and selling at advantageous times, the
same as any other investor. A sizeable portion of penny stock trades are
principal transactions, and an investor should be alert to the potential
conflicts of such transactions.
Bid/Ask
Penny stocks do not each have a single price at which they are bought and
sold, but a number of different prices. The first difference is between
the bid price and the ask price. The bid price is how much someone is
willing to pay for the security, or the price at which you could sell your
shares. The ask price is how much someone will sell their securities for,
or how much you will have to pay. The difference between the prices is the
spread.
The spread
To most investors, the spread represents a built-in loss at the time of
investment. For example, if you purchased a stock that traded at 1/2 cent
bid, 1 cent ask, the bid would have to more than double in price for you
to break even (the "more than double" comes from additional costs such as
"ticket" charges and other miscellaneous costs). Many investors buy penny
stocks believing that "trading at 12® cents" means that they can buy and
sell at 12® cents. This simply is not the case, and any salesperson who
uses such a phrase is only telling half of the truth. The spreads in penny
stocks are most commonly 25-33%, are often 50-100% and sometimes are over
100%.
Another factor to keep in mind when evaluating price information about
penny stocks is that there are two "bid" and two "ask" prices, the inside
and outside bid and ask. As a general rule, the price you will be
interested in will be the outside bid and ask, or the lower bid and the
higher ask, as those are the bid and ask prices to public customers.
Mark-ups
The last pricing factor concerning penny stocks is called the mark-up. A
broker-dealer who has held the security in its account and subject to the
risk of market price fluctuation, may mark the price of the security it
sells to you up by a certain percentage, on top of the spread. This is to
compensate broker-dealers for maintaining inventory sufficient to supply
demand for an orderly and liquid market. What it means to the average
investor is another cost that creates a built-in loss at the time of
investment. In other words, the instant your transaction is effected, your
securities are worth less than you paid for them.
Although it is no guarantee of a good price, you are more likely to get a
better price in an agency transaction using a broker-dealer that has no
interest in the transaction, due to the pricing factors above. In the
typical penny stock transaction, the broker-dealer buys from its customers
at the bid and sells at the ask, capturing as compensation the spread,
plus any mark-up.
Market makers
A market maker is a broker-dealer who stands ready to buy or sell 100
shares of the stocks in which it makes a market. When a transaction is
proposed, the market maker will give a price at which it would be willing
to effect that transaction. The market maker's price applies only to the
first 100 shares. While the market maker system has been widely criticized
(after all, how much of a commitment is it to buy 100 shares at a penny
apiece?) the system does offer investors some
level of fairness. The more market makers there are in a given stock, the
more likely they are to bid against each other, and the price will more
likely move to a true "market" price. The names of the market makers of
securities traded in the pink sheets are listed in the pink sheets.
Manipulation
Especially when there are few or only one market maker, penny stocks are
susceptible to price manipulation. A common and easy manipulation is for a
broker-dealer to gather a large holding of a penny stock at a very low
price. Through the use of high-pressure sales techniques, the sales force
of the broker-dealer hypes the stock and stirs up demand, which seemingly
justifies the continual rise in prices given by the broker-dealer (which
is probably also the only market maker).
The price continues to rise until there are no more investors who will
buy, and then the bottom falls out and the price plummets. Sometimes the
broker-dealer will buy back the securities at the fallen prices to
recapture the stockpile for a future revival of the stock; more often
investors are simply left holding the worthless stock.
Initial public offerings
The price and market discussion above relate to penny stocks already
trading in the market. Stocks are introduced into the market through an
initial public offering (IPO). In most cases, an IPO would need to be
registered with the Securities Division, which applies a set of guidelines
to the offering to determine whether the offering is "fair, just and
equitable." Although the "merit" system of applying those guidelines is
not foolproof, fraudulent offerings are rejected and not granted
registration. For this reason, Missourians are not usually victims of
penny stock scams in an IPO, but lose their money in the secondary market.
In the secondary market, there are broad exemptions in the law that allow
many penny stocks to trade in Missouri without meeting the merit
standards.
Legitimate penny stocks
Despite all of the problems with penny stocks and the millions of dollars
of loss involved with them, there are legitimate companies whose
securities trade in the pink sheets at very low prices. Struggling young
companies just starting out are perfect examples. Investment in such a
company, held through the company's formative years, can pay off well.
Such an astute investment requires three things: the ability to choose the
right company, the capital to invest and hold the investment, and luck.
In order to choose the right company, you must know something about the
business in which the company engages. You must be able to evaluate the
feasibility of the company's business plan and the company's ability to
compete in its field of endeavor. You must be able to evaluate the ability
of the company's management to run the company. Finally, you must be able
to evaluate the capitalization and cash flow of the company.
If you find the right company, you must be able to hold the investment for
years to allow the company to mature and for the stock to appreciate in
value. Investment in "growth" companies is long-term investment.
Furthermore, you must have sufficient capital to be able to withstand
total loss of your investment. Investment in emerging companies is always
a high-risk investment.
Finally, there is simply an element of luck in any stock investment. Luck
plays an even greater role in a market in which manipulation is so
prevalent. Some legitimate companies have had their stocks manipulated to
such an extent that they were forced out of business. Even without
manipulation, the success or failure of a fledgling business is simply
unpredictable.
Sources of information
Your broker can be a tremendous help in evaluating an investment. However,
in the penny stock area, there are many unscrupulous brokers whose only
goal is to sell. Be sure that the advice you receive is balanced and
addresses your investment needs. When in doubt, avoid a penny stock
investment, especially if your broker "specializes" in penny stocks.
The prospectus is the most comprehensive source information about an IPO.
It sets out where your investment money will be used, describes the
capitalization, history and management of the company and describes the
cash flow system of the company. If you need help interpreting the
information you find in the prospectus, the Division has another pamphlet
in this series entitled "How to Read a Prospectus."
Trade confirmations contain a wealth of information. The confirmation will
show basic information, such as number of shares, but will also indicate
whether the transaction was agency or principal, was solicited or
unsolicited (it will say "unsolicited" if you called your broker to place
the order without your broker having tried in any way to get you to place
the order) and, in the case of most pink sheet and non-NMS NASDAQ trades,
provide the bid and ask at the time of execution of the transaction.
Manuals such as Moody's and Standard and Poor's have current financial
information about companies, and most penny stocks are listed in the
manuals.
Periodic reports filed with the U.S. Securities and Exchange Commission
have updated information about companies that register with the SEC. The
most common report is a "10-K."
Warning signs
Watch for the following warning signs to alert you to a possible penny
stock fraud:
High-pressure sales techniques. Investment in a legitimate emerging
company is long-term. A good little company is not going to skyrocket in a
couple of weeks. Building a sound company takes years; you have a few days
or weeks to decide whether the investment is right for you.
Blind pools and blank checks. Do not invest in any security without being
told exactly how your money will be spent. Be sure you know which
properties the company plans to buy with the offering proceeds and how
much money is to be spent on management and promoters.
Mismarked trade confirmations or new account cards. Be very wary if your
trade confirmation is marked "unsolicited" if your broker did, in fact,
solicit the trade. While it may be a simple mistake, unscrupulous penny
stock brokers often mark the confirmation as unsolicited to avoid the
registration laws and the "fair, just and equitable" standard. Watch for
misstatements about your net worth, income and account objectives as well.
Investing in penny stocks is speculative business and involves a high
degree of risk. Often, brokers will enhance the new account card to make
it seem that you are suitable for a penny stock investment when you are
not.
Unauthorized transactions. Be alert to placement in your account of
securities you did not agree to purchase. In some instances, a broker may
try to pressure you into purchasing the stock, claiming that since you
have the stock, you must pay for it. In some cases, the broker is
temporarily "parking" the securities in your account, perhaps to meet the
minimum distribution of an IPO, or for any number of reasons. In some
cases, an unauthorized trade is simply a mistake, but in any case,
complain immediately, both verbally and in writing to your broker, your
broker's manager and to the Securities Division.
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Weekly Thoughts: How To Become a Winner in the Micro-Cap Stock Market.
In the past weeks or two, hundreds of new investors have joined us. We
would like to take this opportunity welcoming all the new subscribers and
wish all of you well and happy as always.
As we know, investing in any penny stock involves a high degree of
investment risk and volatility. All investors are cautioned that they may
lose all or a portion of their investment. The companies (about 6800
companies now) represented on the OTCBB are plagued with deceit and
deception. Impossible to contact corporate officers, no financial reports,
no filings with the SEC, false press releases, pump and dumps filled with
empty promises and delusional visions of grandeur, and so on. The list
goes on and on. But we still love to invest/trade in this wild market,
because there are a few solid small companies out there and we can make
tons of money by investing in them early.
Micro-cap companies are different than large-cap companies. They generally
have fewer shares issued, compared to companies on the major exchanges.
They are younger and have less developed businesses. Revenues are earnings
are smaller. But their product or service or resource has the potential to
be quickly developed into a lucrative business. Many micro-cap companies
are run very efficiently, with little fat. They have competent management
with an innovative product, service, technology - or just an innovative
style. The differences between micro-cap companies is where the profit
potential lies for the investor: thing of the inherent leverage the
micro-cap market has. Most of the companies have only several million
shares outstanding. So when the company has some good news, the value
created is shared with only a few shareholders. The value per share
created can send these stock soaring.
Micro-cap companies are the vehicles for the new businesses, technologies,
processes and applications that are being developed all the time. The
exciting micro-caps are focused on dynamic, emerging new market niches
growing at 30%, 50% or even 100% annually! |
