Picking out a good penny stock involves a lot of effort. However, there are clear red flags which can help you to identify potentially bad penny stock investments. Understanding these red flags and taking the appropriate action can help you avoid significant losses. Let’s take a look at the top 3 warning signs.
#1 Promotions without Credible Reasons
Many times, market-watchers and investors may receive emails that promote certain penny stocks. They may also receive messages from hired promoters about endorsing the penny stocks.
If you investigate closely, you would notice that there may not be any viable reasons for promoting that penny stock –no new product launches, management changes, or products in the pipeline. Such excessive promotions without any credible reason to back it up is a clear red flag about the penny stock.
Interestingly, the stock may also start to surge ahead (with no apparent reason) at the same time. This increase in the price may entice novice investors to invest their money, thinking that it’s a real deal. However, these price increases are usually caused by the company executives and insiders. As soon as regular investors buy a chunk of this penny stock, the original promotors dump their shares and make profits while the genuine investors would lose money when the stock price free-falls soon after.
The general rule of thumb is that if you get the same tip at the same time from multiple sources – via (unsolicited) e-mails, phone calls, or social media, followed by a surge in prices, it usually indicates a pump-and-dump scheme in play. It is best to steer clear from that penny stock.
#2 Excessive Advertisements about the Involvement of Major Companies
Many times, penny stock companies form agreements with well-established companies of the same (or similar) field. This is usually a good thing.
But the red flags pop up when the involvement of the big company is exaggerated. For instance, if the big company had actually invested $25,000 for any program by the penny stock company and the press release from the penny stock company may say that the two companies entered into a “multi-stage development plan” with agreement to spend say, $15 million for the program, it is best to stay cautious about the penny stock company.
Remember that even if there is the involvement of any big companies, they have the right to drop out and cut their losses at any point they want. Therefore, it is not a really valid reason to buy the associated penny stock company.
#3 Penny Stock Companies Formed Before 2010
It is best to thoroughly research about any penny stock company that was formed before the 2010 Dodd-Frank post-crisis regulation. This is because, before this regulation, it was easier for penny stock companies to be set up as shells, get listed on over-the-counter markets and defraud investors.
In addition to these 3 major warning signs, there are plenty more tips to spot a potentially fraudulent penny stock company. You can learn more about those from our professional penny stock course.
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