Penny Stock Risks: The Real Danger Of Pump And Dump Schemes

Investors and traders may be easily tempted by the low prices and sharp price movements of penny stocks, but don’t fall victim to the Pump and Dump scheme and other major risks of penny stock investing. Here’s what you need to know to stay safe.

“Penny stocks” have a low share price of typically less than $1 (up to about $5). New investors are easily attracted to penny stocks because they can purchase a large number of shares for a low amount of money.

Since many mainstream stocks trade for more than $100 per share, an investor with only $300 to invest may prefer to buy a bunch of penny stocks, rather than only 1 or 2 shares of a stock with a much higher price.

Investors (and gamblers) are also drawn to penny stocks because of the perceived opportunity to make huge percentage gains in a short period of time. Penny stocks can be extremely volatile from day to day, enabling investors to literally double their money overnight if a stock trading at $0.10 per share jumps to $0.20 the next day.

The low share price and ability to reap massive gains in a short time is definitely appealing on the surface–but don’t be fooled! In most cases, buying penny stocks is merely a ticket to quickly losing your hard-earned money.

Continue reading to find out about the extreme dangers of investing in penny stocks, especially how to detect and avoid the devious Pump and Dump scheme.

3 Dangers of Investing in Penny Stocks

  1. Penny stocks are known as pink sheets because they are traded over-the-counter via a broker-dealer network, rather than a centralized exchange. Unlike companies listed on major exchanges such as the New York Stock Exchange (NYSE) or NASDAQ, penny stocks do not meet the requirements to be listed on a standard market exchange. As such, penny stocks are not regulated nearly as tightly as stocks listed on a centralized stock exchange. Since the companies behind penny stocks are not held to the same financial reporting requirements as major companies, there is often a lack of legitimate financial information to determine whether the stock is a good investment.
  2. Penny stocks trade less frequently than stocks listed on a public exchange because they are bought and sold over-the-counter. This lower liquidity means you may be challenging to find a buyer for your penny stocks when you are ready to sell them. Even after finding a buyer, you may be forced to sell at a lower than expected price due to low liquidity.
  3. The greatest danger of investing in penny stocks is the frequent occurrence of illegal “Pump and Dump” schemes. A Pump and Dump occurs when an investor or group of investors heavily promote a stock they are holding, then sell immediately after the stock price has risen due to the initial interest in the promotion. The investor(s) behind the hype walks away with a big gain by selling into strength. However, the unsuspecting investor who bought the promoted stock is now left holding a losing stock that has fallen in price due to this unethical and illegal act. Since the Pump and Dump scam is so prevalent in the world of penny stocks, let’s dive in deeper for a closer look at how it works.
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