Sunday, February 11, 2007

The Way Penny Stocks REALLY Work...

Dan Holtzclaw here, author of the Best Selling books The Little Black Book of Microcap Investing and Penny Stocks: The Next American Gold Rush. Let me tell you a little bit about today's penny stocks. Simply put, today's penny stocks are crazy. You find a great looking stock, you perform your due diligence, and what do you get? With a large cap stock, you would have a decent shot at achieving a positive gain. With a penny stock, however, there is no telling what you are going to get. What is going on here?

Let me tell you how most penny stocks really work. I have been trading penny stocks for nearly 15 years and things are constantly changing. Back in the late 1990's you could literally throw a dart at a random penny stock and it seemed that it would eventually go up. In the early 2000's, the MOMO play and pump and dumps were fairly commonplace. What worked for penny stock trading 5 years ago doesn't really work today. So, what is the way of today's penny stocks?

Many think that newsletters still have the ability to manipulate stocks. This was true 5-7 years ago, but I don't think that it is happening much today. Today's investors are too savvy to fall for newsletter hype. In fact, most of today's penny stock emails are now filtered out in our SPAM folders.

Many think that messageboards still have the ability to manipulate stocks. Again, this may have been true 5-7 years ago, but not today. First of all, most messageboards now employ technology based on IP addresses to eliminate multiple alias posting. Second, most messageboards now employ strict spamming TOS policies and they quickly boot those that violate them. Finally, as I mentioned before, today's investors are too savvy to fall for messageboard hype.

The romantic notion of boiler rooms and mafia manipulation may appeal to some, but it is mostly fantasy. The SEC has put a stop to most of these practices.

So, how are today's penny stocks being worked? The trend that I am currently seeing goes like this: A company hires a "PR/IR firm" and pays them with cash and/or stock. The principle PR/IR contacts their "big money" contacts and tells them of the impending "promotion." The big money contacts begin to slowly buy the stock at dirt cheap prices. This is done subtly so as to not drastically cause a price spike. After the big money contacts and the principle PR/IR firm have loaded up on cheap stock, the principle firm then farms out work to smaller firms to pump the stock. This is when the fun begins. The smaller firms will now begin to load up on stock. With so many firms buying up stock for the impending pump, the price of the stock inevitably begins to rise. This price escalation is often discovered by many independent investors and they jump on the bandwagon. How do these independent investors notice this price movement? Many investors utilize computer programs that scan for abnormal price/volume activity. When these alarms are triggered, they jump on the stock. As these individual investors jump on the stock, they alert the messageboards and the masses begin to take note. They see that this stock is starting to move and they want a piece of the action too. By this point, the stock has become a hot topic on the boards. Without anyone doing any pumping, the stock has now risen substantially. To light the final fuse on the powder keg, the principle firm will now utilize the cash that it was paid for the promotion to push the stock past the last resistance levels. When this happens, the stock makes a big move and everyone rushes in. As the stock makes it final ascent, the principle firm begins to dump its free and acquired shares to the lemmings that are now rushing into the stock. Typically, the principle firm will not tell its hired firms when it is going to sell. The principle firm will let the smaller hired firms fend for themselves. When the principle firm dumps its shares, the price will eventually begin to fall. On top of this, the MM's will typically begin to short the stock now that it has achieved significant gains. This selling and shorting begins to crush the stock and it quickly tumbles. In most cases, the little guys that were late to the party are left holding the bag while the MM's and the principle firms get rich. In all reality, the principle firm didn't do anything illegal. They did not pump or tout the stock. They did not spam the masses. In fact, they typically remain completely behind the scenes. Call it the "pumpless pump" if you will.

The thing about penny stocks is that there is alot going on behind the scenes that most people don't know about. On one hand you have MM's shorting stocks. On another you have shady investment firms utilizing convertible debentures and death spiral financing to milk companies dry and leave regular Joe investors holding the bag. In all honesty, even with today's new standards, it is very difficult to make an honest penny stock investment.

In the past, I once had nearly all of my investments tied up in penny stocks. Today, this is not the case. Simply put, the cards are stacked against you if you limit yourself to penny stocks and eventually you are going to lose. This is why I now focus on MICROCAP stocks. By focusing on microcaps, I can still pick up some good penny and subpenny stocks, but I factor in a measure of safety. There are ways to win at the game of penny stocks. In the Little Black Book of Microcap Investing, I show nearly half a dozen ways to make money with microcaps. To date, 3 of the predictions in my book have already come true! I predicted that Bio-Lok would be acquired and it was! I predicted that the AMEX stock FFI would significantly appreciate in value (it recently rose nearly 100%!). I predicted that TBSI would rise (it has recently risen nearly 100% in value!). If you have not purchased this book, you are missing out! While these predictions were great, I feel that my best predictions are still waiting to come true! You can get the book at a significant discount by clicking here!

As always, please see my disclaimer

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