If you are like me, you have probably received dozens of emails about stock tips where a certain stock is set to skyrocket in price, and you have to get in now or the deal of the century is going to be gone, etc etc.
I'm naturally a cynical person, but if I had a great stock tip, the last thing I would do would be to share it with a bunch of strangers.
Unfortunately, the internet has allowed a scam involving penny stock to flourish where many people get suckered in and end up losing a lot of money.
The purpose of this article is to outline how the scam works and how to avoid it happening to you.
First, the basics Before I go on any further, I feel I need to give you a quick run down on how the stock market works.
In simplistic terms, the stock market is driven by only two major factors: Greed and Fear.
However, in our case here, the law of supply and demand is more relevant.
If more people want a certain stock than there are people willing to sell it, then the price will rise.
If there is an abundance of the stock and no one wants to buy it, the price will fall.
Pretty simple, wouldn't you say? Time to read on to the next step...
The scenario Let's say Shady McInvestor has a packet of penny stocks in ABC company, a small-cap mining company.
He bought them at $1 each and they have now risen to $2.
Great! He thinks he's doubled his money, but in reality he hasn't, as he needs to actually sell the stock before he realises a profit.
So, he puts his order in to sell his shares at $2.
A bit of time goes by, but no one actually buys them.
He drops his price to $1.
90.
Again, no one buys them.
He drops them further to $1.
50, yet no one buys them.
Suddenly, his huge profit is dwindling because no one is buying them.
This is what commonly happens with penny stocks because they are not very "liquid".
His first mistake was buying shares at $1.
00 each, when in fact they were extremely overpriced and in reality were worth only about a tenth of the price.
Many savvy (or smart) investors and traders would be able to do a little bit of research into ABC Mining company and easily determine that the fair price for the shares would be only about $0.
10, so why would anyone want to buy them at a much higher price? Shady's now desperate to get rid of them, but how can he do it if no one is interested in buying them? Therefore, he needs to somehow drum up interest in these shares.
This is where the scam comes in, so read on! How the Scam Works By now, the share price has dropped to only $0.
50 (still over priced) because no one is interested in buying, and the huge profit that Shady McInvestor had is not only gone, but his losses are growing each week, and he is worried that he may lose all his money in penny stocks that are going down in price.
He needs to make these shares look like a great investment so other people may want to buy them.
This is where it may become familiar to you and your email inbox! He sends an official-looking email (one that looks like insider information!) to 10 000 (or more) people, saying something like: The current share price of ABC Mining company is $0.
50, but is forecasted to reach at least $2 or more due to (insert an official sounding reason here).
This means a return on investment of 300%!" Suddenly, if someone is given this supposed "insider information", they will consider buying the stock.
However, if a lot of people are duped by this email scam, there will be more interest in the stock and more people are likely to want to buy it.
This will cause the share price to rise because suddenly more people want to buy it.
Before you know it, the price has risen to over a dollar, and Shady McInvestor is able to sell his shares.
However, the people who bought the shares are now holding them and guess what happens? That's right, because the shares were in reality worth hardly anything (maybe $0.
10), the share price drops to where it should be, and many greedy people have lost a lot of money and now hold a lot of shares they can't get rid of.
Shady doesn't care, because now he doesn't have the shares and may have made a little profit.
Need Proof? I used to get a lot of these types of emails, and I never paid any attention to them.
One day I decided to do a little bit of research and see for myself.
I got an email that said something like "company XYZ is currently at $0.
13 and is forecasted to reach $0.
30 by the end of the month".
This would have given me a profit of over 100%.
I went to BigCharts.
com, which is a website that allows you to see a chart of virtually all stocks traded all over the world on all markets.
I entered the details of the company and lo and behold, the price really *was* $0.
13 (or very close to it).
Was the email true? Well, technically it was, but it didn't tell the WHOLE story.
I looked at the history of this penny stock and found that six months ago, it was trading for well over $0.
90, which means that it has lost over 85% of its value in the last six months...
why would this be unless the company was lousy and was heading into bankruptcy!??! Quite likely, this email came from a person (or company) looking to offload a lot of these soon-to-be worthless shares and were sending out these spam emails with supposed inside information to make you think the share price was going to go through the roof and it would hopefully generate a lot of interest.
How to avoid getting scammed The easiest way to not get scammed is to simply not reply to these emails and hit the delete key.
What makes you think that you are lucky enough to get this information? If it sounds too good to be true, then it probably is.
If you are little more savvy in your investment decision-making, you can always investigate the stock yourself (you can't lose money just by looking!).
More than likely, if you were to get a chart of the stock, you'll find that the share price is on a huge downtrend and is now worth only a fraction of what they were worth a year or so ago.
If a company loses 90% of its value in less than a year, wouldn't you think that something is wrong? However, if the chart still doesn't convince you, talk to your broker about ABC Mining Company (or whatever company the email mentions).
More than likely, your broker can give you all sorts of information on the company, but he/she can also give you his/her opinion of the investment.
In the end, making up this type of scam is not only unethical, but is also highly illegal.
Unfortunately, many people still get scammed through things like this and end up losing thousands of dollars, all through greed.
What's worse is that those who come up with these scams may end up making a huge profit.
believe it or not, many of these scams don't originate in places like Nigeria, but are in major cities such as New York, London, etc.
I don't want to discourage you from penny stocks, nor do I want you to think that this is the way all penny stocks work.
Far from it actually.
Most small-cap companies are merely trying to raise revenue for research through selling shares in the company the same way all large companies do.
They do it legally and ethically, and can actually give investors a large return in some cases.
But you need to know that these types of scams are out there! Now that you know how to protect yourself, don't get caught out by these scams.
If possible, report these to the local authorities or at least your ISP.