Beware any insider information when trading penny stocks.

If you are ever offered insider information by anyone, don’t be tempted to act on it. Strict rules are in place and if you are found out, not only will you have to repay any profits made but you will more than likely face a heavy fine or worse.

Inside information does not pay in the end and you should not buy a stock if you inadvertently receive any, even if you were going to buy the share in the first place.

The authorities will view your trade in light of any inside information you may have received and will act accordingly.

Todd B.

Beware penny stocks in untried markets.

Whilst many microcap companies are in standard products, in established markets many are not, focusing instead on new untested products and untried markets.

Whist doing your penny stock research you want to be able to research the market for the product and the newer and more untested the product and market, the harder this will be to do.

A new computer product in an established market is OK but not in country or market with low computer use. You need to make sure there is a demand for the product.

People buy products that fill a need for them not the company making the product.

Dave J.

Investors often misunderstand bankrupt penny stocks as they are unsure of the bankruptcy process. They assume the company is now protected from further financial harm.

In reality, all bankruptcy protection means is the company can no longer be pursued by creditors and that it can prepare a repayment plan and that the company will be reorganised.

The company can still be liquidated if it no longer has the cash to carry on or it can simply cease trading. And once that happens the stock is worthless.

Such reorganisations rarely favour penny stock investors as, being equity holders, they are behind creditors and bondholders who often take effective control of the company as a result.

Many penny stock investors believe they will receive stock in a new reorganised company or buy the stock thinking they have got in at the bottom of a turnaround situation. Unfortunately in 99 times out of a 100 this is not the case and they lose their entire investment.

Todd B.

The biggest penny stock risks come about via negative situations that adversely impact the stock price.

Over the next few weeks we’ll be looking at various negative situations to look out for.

The Reverse Split

Company share splits are common among the larger Blue Chip companies as a way of issuing more shares and reducing the share price.

Conversely, reverse splits do the opposite. A company having a 100 for 1 reverse split is reducing the number of shares outstanding by 100 times.

After the spit the price of the shares reflects the new ratio. So a penny stock worth $0.05 suddenly becomes valued at $5 as it is 100 old shares. So, if you were holding 100,000, at $0.05, worth $5000 you now hold just 1,000 shares, at $5 also worth $5000.

So, initially the value of the shares remains the same.

However, rarely do investors believe that the stock will retain the new higher price, it is a still a penny stock company after all.

Investors will start selling the stock on this lack of confidence which will, in turn, trigger more investors to sell.

Also, the reason for the reverse split in the first place is so the company can issue more shares and when they do this further deflates the share value.

We would not recommend buying or holding a stock that will shortly be the subject of a reverse split.

Todd B.

Obviously everyone want to buy into a rising penny stock but there has to be a limit.

The problem with buying into a penny stock that has risen more that 100% in a one week period is that many investors will be sitting on profits of up to 100%. At this point those investors can sell and walk away with big gains.

If you buy into the stock at this point you run the risk that those investors will cash in and sell their shares and the price will drop significantly often back to the the price they bought at. You should therefore restrict yourself to buying stocks that have moved less than 50% in a one week period.

Most penny stock investors will wait for a 100% gain before considering profit taking even if the fundamentals point to even higher gains. Even if there are some sellers at this level, pegging the price back, your risk is smaller and the price will likely continue to rise as investors again see the stock as a bargain.

Todd B