A customer backlash against a penny stock is probably the worst thing that can happen.

A customer backlash with be very damaging to the company and its penny stocks. When customers decide that they can no longer trust a product or service they will never buy it again.

Microcap companies do not have the cash cushion of larger, more established firms and are ill placed to weather any storms. Nor does it have the PR resources to dampen the blow.

Any penny stock that is the subject of a significant customer backlash is not likely to survive for long. Stay well clear!

Todd B.

Government investigations always have an adverse effect on a penny stock.

Even if the company being investigated is subsequently cleared. By the time this happens the company’s name has been tarnished. Any investors who become aware of the investigation will assume the worst and react accordingly.

We would not invest in a company that is subject to a government investigation as it is likely there was some reason the company was being investigated in the first place. Even if the investigation turns up nothing untoward, they will have had to spend a lot of time and effort cooperating with the investigation, time not spent on urgent company matters.

It is likely the share price would take months if not years to recover.

Dave J.

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

If you are interested in a particular stock look out for any penny stock short sellers. Short sellers have to borrow stock from brokers to sell the stock as they do not already own it. They hope the price will fall significantly so that they can buy back the shares at a much lower price, make a profit and return the shares to the stock lender.

This is a very risky way of stock speculating and is usually only carried out by experienced investors. Such investors carry out a great deal of research and would be expected to have a good reason to be shorting the stock.

A short seller may short a stock because he expects the company to default on a loan, for example. It is important for you to try and determine why a stock is being shorted and to only invest in that stock is you fundamentally disagree with the reason.

Otherwise if you are aware that a particular penny stock is being shorted, stay well clear.

Dave J.

When picking penny stocks via an internet news or information service it help if you refine your search criteria.

Over time you should could compile a list of your own keyword phrases to use. Perhaps you have a particular interest in oil stocks or internet stocks. Base your keyword phrases when searching for penny stocks around hot areas, sectors, products, people and places.

Here are some other keywords that crop up time and again in our penny stock searches:-

• OTC
• pink sheets
• listing
• featured
• recommended
• internet
• profit
• merger

Todd B

One good way to determine your penny stock selection criteria is to use a news service like Businesswire.com.

This is a news service that collects press releases from public and private companies and then sends out the release on its business wire. Publications can then decide which releases they want to use in their business news sections. As an individual penny stock investor you can also log in to the service and read all the daily press releases yourself. Information direct from the companies.

Naturally you will not want to read every single article so it is important that you filter the information by using relevant keyword phrases in your article searches. As you are primarily interested in penny stocks you could start with a keyword phrase including OTC.

You may want to couple that with the industry name you are interested in, for example, ‘OTC Mining’. You certainly want to refine your search beyond ‘penny stock’. Scan the article headlines and read the articles that interest you. Then do a further search using the company name.

Try to get into the habit of scanning the press releases on a daily basis, preferably first thing in the morning.

Dave J