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What is meant by "penny" or "pink sheet" stocks? Are they the same thing? Thanks, S.F.
The term "penny stock" has generally been used to describe low-priced securities issued by small companies. A penny stock is usually priced at less than $5 per share and is not traded on the
or listed on a stock exchange where it may not meet listing requirements.
Instead, these often speculative stocks trade on another component of the over-the-counter market commonly referred to as the "pink sheets." Many years ago, the prices for these tiny stocks were disseminated on sheets of pink paper, hence the name. Unfortunately, the prices were often stale and investors would be forced to call their brokers, who would in turn call market makers to get the prices.
The name stuck, but the Internet has provided a much simpler way to get up-to-date quotes. Investors can now just go to
PinkSheets.com for the latest quote.
But before heading over to the site, it's important to note that the Pink Sheets market is often referred to as the "Wild West" of markets in the U.S. Unlike the major exchanges, there are no minimum quantitative standards for a company to list its stock on the Pink Sheets.
In other words, buyer beware! And that is especially true when penny stocks are rallying.
"When you get down to the bulletin board, a lot of the trading is done by the public daytrader passing stocks and stories back and forth," says Phil Roth, chief technical market analyst at Miller Tabak. "And in this environment, when stocks have advanced for a long time and people have confidence, they will buy anything. A 10-cent stock can go to 50 cents, just for lack of sellers."
Manipulation is the biggest worry for traders playing with penny stocks, and those fears have only grown with the explosion of the Internet. Individual investors and NASD firms have been busted for various schemes involving stocks of small-cap, and even some large-cap, stocks, with the most famous scam being the "pump and dump."
According to the
Securities and Exchange Commission
, "Pump and dump" schemes, also known as "hype-and-dump manipulation," involve the touting of a company's stock through false and misleading statements to the marketplace. After pumping the stock, fraudsters make huge profits by selling their cheap stock into the market.
"Pump-and-dump schemes often occur on the Internet, where it is common to see messages posted that urge readers to buy a stock quickly or to sell before the price goes down, or a telemarketer will call using the same sort of pitch. Often, the promoters will claim to have 'inside' information about an impending development or to use an 'infallible' combination of economic and stock market data to pick stocks," says the SEC's Web site.
"In reality, they may be company insiders or paid promoters who stand to gain by selling their shares after the stock price is 'pumped' up by the buying frenzy they create. Once these fraudsters 'dump' their shares and stop hyping the stock, the price typically falls, and investors lose their money," the site continues.
Despite all of the problems with penny stocks, there are legitimate companies whose securities trade on the Pink Sheets. In fact, many struggling young companies start out on the Pink Sheets and eventually grow large and profitable enough to jump to a major, national exchange.
It's also worth making the distinction between the Pink Sheets and the OTC Bulletin Board. Companies on the Pink Sheets are not required to meet minimum requirements or file with the SEC, whereas OTCBB companies are required to file current financial statements with the SEC or a banking or insurance regulator.