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Problems Investing in Penny Stocks, Over the Counter Bulletin Board, OTCBB and Pink Sheets
There are problems when you invest in penny stocks. You probably get hot tips every day at the water cooler or on the golf course or in your email box about the next big thing in penny stocks. You may hear them called Over the Counter stocks, Bulletin Board stocks, OTCBB or pink sheet stocks. The tipsters promise you amazing returns with a rags to riches story, maybe even double or triple your investment within a few days. Penny stocks can be a slippery slope with problems for the investor who looks for the instant gratification of a quick fix. Here we clear up the problems investing in penny stocks, over-the-counter bulletin board stocks, OTCBB, and pink sheets.
Trading Penny Stocks
The best way to describe a penny stock is any stock that is trading on the Pink Sheets or OTCBB, Over the Counter Bulletin Board. A penny stock typically sells for less than $5 a share, and more often for less than $1. These problem stocks are considered high-risk investments with low trading volumes. Investors are cautioned to avoid these risky, speculative stocks, and here's the whole truth.
The expression "penny stocks" and "micro-cap stocks" are often used interchangeably, and definitions are not clear-cut. A stock with a market capitalization between $50 and $300 million is a micro-cap. And with a market capitalization less than $50 million, the stock is a nano-cap. The SEC calls any stock under $5 a penny stock, but other people use $3 and $1 as the cutoff point for penny stocks. Securities of micro cap companies are also quoted on the Nasdaq Small Cap Market. FYI, market capitalization is the market value of the company stock, the product of the number of shares of stock outstanding times the price per share.
To summarize the problems, penny stocks trade at relatively low prices and with small market capitalization, outside of the major market exchanges. They are highly speculative and risky. These securities represent companies that do not qualify for trading on a national stock exchange or on NASDAQ for various reasons. Here are more problems you face if you invest in penny stocks.
The Problems You Face When You Invest in Penny Stocks
For your information, the two major stock exchanges in the USA are NYSE, The New York Stock Exchange, and NASDAQ, The National Association of Securities Dealers Automated Quotation system. Other stock exchanges are the American Stock Exchange, Chicago Stock Exchange, Pacific Stock Exchange, Philadelphia Stock Exchange, Boston Stock Exchange, and Chicago Board Options Exchange.
- The problem is that the price of a penny stock is set by the market makers in the stock. Market makers conduct all trading in these stocks. Their bid and ask prices are what you can expect if you buy or sell a penny stock. One of the problems investing in penny stocks is that the spread between bid and ask price is quite large, say $1 spread on a $5 stock, so the market maker is often the biggest money maker in the deal.
- Another problem investing is that penny stocks lack liquidity. Because there are few investors for penny stocks, you cannot sell your shares easily. There are few trades and your trading order may not be filled.
The prices on any actual trades are not disclosed to the public, unlike trades on a major stock exchange.
- Another problem with penny stocks is that your online broker has restrictions when you trade Over the Counter Bulletin Board, OTCBB, or the pink sheet stocks. Your online broker may accept limit orders to buy and sell penny stocks for your account, but they do not recommend this type of investing and warn against it. They will not accept your MARKET order to buy a penny stock, but only LIMIT orders, where you specify the exact price you are willing to pay. Brokerage houses will also not accept margin orders for penny stocks, that is to say, you cannot borrow from them to purchase penny stocks. These restrictions are to protect you against price fluctuation and inaccurate quote information that often accompanies penny stocks.
- There are more problems with penny stocks and over the counter stocks. You will notice frequent listing changes for these stocks. The stock symbol may change or the name of the company may change, and there are often splits, reverse splits, de-listings and relistings. The company could also be facing bankruptcy. It's up to you as the investor to be aware of these problems before you invest.
- You can recognize pink sheet penny stocks by .PK at the end of a stock symbol. The suffix PK shows that the stock trades on the Pink Sheets Electronic Quotation service. Pink Sheets is not a stock exchange, but a daily publication with bid and ask prices of over-the-counter penny stocks. Originally the end-of-day stock data was printed on pink colored sheets. Visit pinksheets.com for more information.
- You can recognize Over-the-Counter penny stocks by the .OB at the end of a stock symbol. The suffix OB means that the stocks trades on the Over-The-Counter-Bulletin-Board, an electronic trading service offered by the National Association of Securities Dealers. Stocks listed by either of these services do not have to meet minimum financial requirements. Visit otcbb.com for additional information
- What is OTCBB, Over-the-Counter Bulletin Board? The OTCBB is an electronic trading service that shows quotes, last-sale and volume for the securities listed on it. Stocks that trade on the OTCBB, use the suffix .OB with their stock symbol, as in INHI.OB.
- Another problem investing in penny stocks is that there are few requirements to list these stocks. Any stock can be listed Over the Counter, OTCBB, just by filing current financial statements with the SEC or a banking or insurance regulator. There are no other requirements to meet for stock price or market capitalization or the quality of the company, and these stocks are not part of the Nasdaq Exchange. On the other hand, stocks listed on the NYSE or NASDAQ meet requirements as to share price and market capitalization, and disclosure of information.
- Since penny stocks are not traded on electronically linked execution systems, the problem with penny stocks is that accurate quotes and immediate executions may not be available. Your trades are exectued manually by a market maker, a company that decides to make a market in a stock. You may only receive a partial execution or your order may not be executed at all depending on the number of shares and market makers available. Therefore, there are many times when you see trades above and below your price and yet your order is not filled
- If you want to invest in low-priced stocks without the problems of investing in penny stocks, there are some very large companies, based on market capitalization, whose stock price is under $5. Many of these companies can be found on the New York and NASDAQ stock exchanges. These companies are not classified as penny stocks.
- Another problem with penny stocks is that both the Pink Sheets and the Over-The-Counter Bulletin Board markets are subject to a great deal of market maker discretion. Order priority and representation rules which apply to exchange listed stocks have absolutely no bearing on the OTCBB market.
- The Over-the-Counter Bulletin Board, OTCBB, does have rules to protect your limit order, but these only guarantee that the market maker holding your order cannot trade at a price better than your order. The problem is that other market makers can trade penny stocks around you. Rules do not require the market maker to "reflect" your order to the rest of the market, and rules do not prevent a different market maker from trading at or through your price. You trade with one market maker, not with another investor. Therefore, many times you will see trades above and below your price while your order is not filled.
- It's a major problem that penny stocks are often the subject of fraud and market manipulation. Because dealers control the market, they can set prices arbitrarily. A pump-and-dump scheme is a campaign by company insiders to inflate the stock price, sell their shares and let the price fall where it may. You may lose all or much of your investment in penny stocks.
Pump and Dump Example #1. The musician and businessman 50 Cent who had a successful $100 million partnership with Vitamin Water, is now famous as the owner of 30,000,000 shares of H&H Imports, which is 12.9% of the company, a penny stock with stock symbol HNHI. He used his tweets on Twitter to pump up and artificially manipulate the stock shares in the company to about 4 times their price. His investors now face the problem of disposing of the stock.
Performer 50 Cent
Pump and Dump Example #2. LEXG.OB, Lithium Exploration Group. has been called the biggest stock promotion of all time. The market cap reached over $350 million at one point while the revenues for the company were zero. The mass mailing said, “One Company Sits on a Multibillion-Dollar Bonanza.” LEXG was a penny stock priced below $.10 per share before the pump, and it skyrocketed to a high $10.68 on April 28, 2011. All this brouhaha for a company that listed NO assets on its 2010 balance sheet.
Lithium Exploration Stock Chart
- Wal-Mart and Microsoft were never penny stocks, no matter what you've heard. In fact, these companies began trading at $28 and $25 respectively. Since then the stocks split often, so that the stock price on the first day, adjusted for splits, was about $.09722 and $.02444. But these were not trading prices. Very few penny stocks on the OTCC ever make the transition to a major exchange, because they seldom become large enough.
- Another problem is that some penny stocks represent shares of companies facing bankruptcy and uncertain survival. After a company is reorganized in bankruptcy, the shares you own could be almost worthless. Often these companies have little or no revenue, much less profits. Here are a few famous companies whose shares became penny stocks:
Fannie Mae (FNM) (FNMA.OB) at $.26
Freddie Mac (FRE) (FMCC.OB) at $.27
BLOCKBUSTER INC (BBI) (BLOAQ.PK) Now Blockbuster Liquidating BLIAQ at $.02
The Great Atlantic & Pacific Tea Company (GAPTQ.PK) at $.01
Nortel Networks Corp. (NRTLQ.PK) at $.01
Lehman Brothers Holdings Inc. (LEHMQ.PK) at $.03
Eastman Kodak (EKDKQ) currently trading at 27 cents
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