How to Avoid Penny Stock Scams

The temptations of penny stocks are legion. It's hard to resist a cheap stock, especially a "sub-penny," which is worth a teensy fraction of a cent. Loading up on a few hundred thousand shares looks impressive on your account statements and holds out the promise of massive profits if the company succeeds. Unfortunately, most penny stocks will stay just that, and there are more scams than legitimate opportunities in this corner of the investment world.

Disconnecting the Call

Avoiding penny stock scams means avoiding penny stock promoters. Some of them come by phone, some by mail, some by your email inbox. If you receive an unsolicited "cold call" from a stock promoter, the wisest course of action is to politely terminate the call. If you decide to listen to any advice, think carefully over the logic of a total stranger taking any interest in your financial well-being. Seek advice on your own initiative and only deal with financial advisers you know and trust.

Newsletters and Email Alerts

The Internet is well populated by newsletters and email alerts produced by stock promoters. Your would-be benefactors, more than likely, are earning money from the companies they are promoting as investments. As a result, their advice is somewhat less than trustworthy. Don't pay for subscriptions, either. Free advice and stock tips abound online, and the best source for legitimate books, magazines, newsletters and financial information is the public library.

Due Diligence

If you come across a potential investment, research the company by going online to a neutral financial source (CNN Money, MSN Money, Yahoo! Finance, CNBC and Morningstar are good sources) for information on the company's history and earnings. Look for a balance sheet and income statement. If the company doesn't produce them, pass it by. While some penny stocks file SEC-required reports such as 10Ks, others don't, and they aren't required to by the rules of the bulletin board or "pink sheet" service that quotes their stock price. Without this information, you're trading on rumors, and your hoped-for winner may be nothing more than a few names and numbers on paper -- and a con.

Play Trade

If you decide to pull the trigger on a penny stock, don't risk money you can't afford to lose (this goes for stock investing in general). If you make the investment, stay with it and don't try to time the market by jumping in and out. The stock price will be volatile, but if the company is legitimate and shows earnings, your returns for the buy-and-hold strategy will be much greater -- potentially in the multi-thousands on a percentage basis. You may also use a practice account to get a feel for penny stock trading.