Buying Penny Stocks: Beware of the “Pump and Dump”

Although the past few posts have been about buying penny stocks, I should have actually titled this post “How NOT to Buy Penny Stocks”, because I’m going to cover the somewhat “seedier” side of stock market investing, where the majority of the unwary really get their shirts taken in short order. I’m talking about a particular scam called the “pump and dump”, which is notorious among penny stocks, or to use a more technical term, microcap stocks. Microcap stocks are basically (without getting too technical about it) securities issued by any company that has less than $10 million in assets, and most of the time WAY less than that. I’m actually convinced that there are some microcap companies that operate off of one telephone in some dude’s mobile home. The regulatory demands on microcap are nowhere near as strict as other stock exchanges, such as the NASDAQ (National Association of Securities Dealers Automated Quotations), AMEX (American Stock Exchange), or (of course) the NYSE (New York Stock Exchange). In the world of penny stock trading, the OTCBB is the most prominent exchange for penny stocks, and at the same time the most susceptible breeding ground for fraudsters, scammers and con artists. The main reason for this is again the fact that these microcap companies are not held to a high level of accountability as far as the information they provide to the public is concerned. Their accountability to the SEC (Securities and Exchange Commission) is primarily having to file the usual reports, such as the 10-Q and so forth, which are far too boring to get into here. I’m not really an expert on that aspect of stock investing, and would have to do much more research to sound intelligent on that topic. This is actually a good sign, though, because I am living proof that you don’t have to know all that fundamental mumbo-jumbo in order to make money trading penny stocks. All I really know is that when the companies are late in filing their reports to the SEC, they get an “E” added to the end of their ticker. So for example, if a hypothetical company (ticker: CRUD) did not file their reports to the SEC on time, they would now be labeled CRUDE until they filed current reports again. Again, this aspect of penny stock investing, and actually fundamental stock investing in general, is not really my cup of tea, and pretty much bores me to tears.

Back to the “Pump and Dump” scheme. What happens most of the time is that barely-legit microcap companies will hire promotional firms to write extremely hype-filled reports touting their stock, and how it’s about to explode due to this-and-that economic indicator, plus some promising big deal the company is about to land, on and on, you name it and they’ll include it. Normally the promotional firm will then fax blast the report to gazillions of fax machines, as well as posting these types of reports on the Internet through investment chat rooms, all to entice the unwary into buying “before it’s too late”. Again I say, by the time the public hears about it, the insiders have already made their money. Long story short, the stock is hyped to an infinite degree, only to incite public speculation, thus making the market liquid enough for the REAL investors to sell out. These promotional firms are normally paid in either cash or blocks of very cheap stock from the company, which they then sell once the price becomes extremely over-inflated. At the end of the day, it’s simply a hype-fest designed to get the fools to soon part with their money. In one sentence, the stock is featured, hyped, and then sold to the public, who ends up holding the bag with the really big hole in it.

Again, OTCBB penny stocks are famous for being featured in these schemes. You have to know what you’re doing before even trying to enter this arena of trading, because if you don’t, you’ll know the true meaning of the following investment axiom: “When a man with money meets a man with experience, the man with the experience will get the money, and the man with money will get an experience.” The only way you can even halfway know what’s going on is to read the stock’s price chart. Watch the volume figures. Observe the minor spikes and dips and how the volume relates to them. When you see a stock trading quietly in a small range (not much fluctuation within the trading day, price-wise), on light volume, and this goes on for days and/or even weeks in a row, you’re looking at a penny stock that’s being “primed for pumping”. In short, it’s a setup. This tight trading range, which can really only be detected by analyzing a price chart, is called the “accumulation” or “base” phase of the stock, where the foundation of the move up is being built by the insiders. While this price action looks extremely discouraging to the average public speculator, it’s exactly the kind of action you look for when you’re “in the know”.

Unfortunately, I must sign off due to some business that I have to attend to, but I recommend that you go to Big Charts and just start examining the price charts of different stocks that trade on the OTCBB. Check out the OTCBB website for a list of stocks to watch—check out especially the “Most Active by Volume” list. This will be a good informal introduction into what it takes to know how to buy penny stocks.