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|Table of Contents:
Preface --- P.2
Chapter 1 - What is a Penny Stock? --- P. 8
Chapter 2 - The OTC Market --- P. 11
Chapter 3 - The Pink Sheets --- P.19
Chapter 4 - Research Tools ---- P. 27
Chapter 5 - Financial Fundamentals --- P.55
Chapter 6 - Corporate Developments --- P.75
Chapter 7 - Turn Around Situations --- P.96
Chapter 8 - Special Situations --- P.107
Chapter 9 - Insiders --- P.116
Chapter 10 - Research --- P.129
Chapter 11 - Investor Relations Firms --- P.165
Chapter 12 - Negative Situations --- P.180
Chapter 13 - Investment Strategies --- P.189
Conclusion – P.212
Preview of the Penny Stock Trading System ebook:
This book is focused on penny stocks. While there are many different types of investing one can partake of the author believes that micro cap investing is the most rewarding one. Micro cap investing has the potential to yield huge gains in a short period of time. It is very common for penny stocks to move upwards of 25% in any given day. Keep in mind that the adverse means that they can also move down 25% on any given day. The nature of penny stocks makes them both very rewarding and very dangerous. Then why invest in them at all? Because in this world the more risk you take the more reward you are posed to gain. If you put your money in a bank account you will eliminate all risk short of a total banking melt down. You will always be able to access your money regardless of the general condition of the market. A bank account seems like the perfect type of investment vehicle until you realize that the interest you earn hardly keeps up with inflation after you have paid taxes.
You can then choose to increase your tolerance of risk and invest in a bond with relative security and safety. You will then have peace of mind but also a very small return on your investment. If you decide that you are willing to risk your money you can enter the security arena via a mutual fund or the purchase of a security like General Motors and hope that by the end of the year your investment has grown by 20%. You have increased your risk and have increased your return potential at the same time. By investing in an established mutual fund or company you have both minimized your risk and potential at the same time.
But what if you wanted the opportunity to double or triple your money in a month? You would be hard pressed to find a stock trading on one of the larger exchanges that had the potential to double in a month. Now keep in mind that if a stock existed which had the potential to double in a month it would also have the potential to lose all of its value in a month. But what if you decided that knowing the huge risks you were about to undertake you still wanted a crack at buying stocks that could double your money in a month. You would find those stocks among the ranks of the penny stocks. These companies would be small companies with small operations but large aspirations. These companies would be driven by a dream and the necessary ambition to beat the odds. The odds would be stacked against them in many aspects. A majority of these companies will never progress beyond the development stage. But the slim percentage of companies that do beat the odds can experience dramatic growth in their stock prices of upwards of 10,000% in a year.
So is it worth investing in penny stocks? The answer is yes and no. You will have to look within yourself and discover if you have the ambition and persistence to learn everything there is about penny stocks. This book should prove to be more than enough ammunition to beat the odds and discover the right next penny stocks. But it is up to you to decide if you have the courage and ability to take the large risks associated with investing in them.
Use this book as an educational manual, and make sure to consult a broker before making your decisions. This book is not meant to give advice, it is only written for educational purposes. Read the conclusion of the book before making any investment decisions. It is located at the end of the book. Good luck.
Before we can enter the penny stock arena we have to a clear grasp of what it is we are dealing with.
We need to have a definition of what a penny stock is and where it trades. Without a basic definition of the stocks we will be investing in we will make countless mistakes out of confusion and lack of direction. Like any entrepreneur, an investor must know what the market they are entering is comprised of. She must research it fully and know all the details that pertain to the given business segment she is entering. Before she commits one dollar to her new pursuit she will make sure that she knows everything there is to know about her market cold. We will emulate the entrepreneur by learning everything there is to know about penny stocks and the market they trade in. In order to do so successfully we will analyze the penny stock market from the ground zero.
To start with we need to decide upon a definition of what a penny stock is. Some investors mistakenly assume that a penny stock is a stock that trades for a cent. While there are many stocks that trade for a cent and when traded correctly can yield vast profits, the definition is broader. Some investors consider any stock trading under $5 to be a penny stocks. Those investors seek to avoid stocks they deem to be highly risky. By labelling any stock trading under $5 a penny stock they help separate themselves from what they see as highly risky securities. While both definitions are accurate four our intents and purposes we will define a penny stock as any company trading on the over the counter market. Our definition of a penny stock will eliminate stocks trading under a dollar on the New York Stock Exchange or stocks trading for .50 on the Nasdaq Small Cap market. The reason we will not consider those stocks to be penny stocks is because more often than not a stock trading for under a dollar on one of the larger exchanges will soon be delisted due to dire troubles in its business. A stock trading under a dollar on a major exchange most likely once traded way above that price and now due to either mismanagement or external factors is in financial troubles and headed for bankruptcy. While there is an art to investing in those companies I have found that it is more profitable to invest in companies that are still awaiting their future than companies which have already experienced what the future holds for them and are now in decline.
The market cap is not relevant at this point. Later in the book we will discuss how to use the market cap when deciding on a stock. At this point our only definition of a penny stock is a stock which trades either on the over the counter market or on the pink sheets. You must be wondering why I would ignore the market cap when defining a penny stock. There are many penny stocks with share prices in the dollar range and a market cap of over a few hundred million dollars, sometimes even equalling a mid cap in the price of their market valuation. Clearly those companies should not be considered penny stocks any longer? If they are worth more money than an established company trading on the Nasdaq then they really are not penny stocks any longer?
The answer depends on the company and on the market valuation for that type of business. We will discuss in a later chapter how to understand and come up with a fair market cap for a company. But for now we will ignore the market cap and focus on the market the stock trades on. The only other parameter we will use to define a penny stock is that it must be trading under a dollar at the point we buy it. We might chose to hold a stock as it climbs above a $1 but we will never consider a stock over a $1 to be a penny stock for our purposes.
What is the over the counter market? The over the counter market, known as the OTCBB, which stands for Over The Counter Market Bulletin Board, is a regulated quotation service that displays real time quotes, last sale prices, and volume information in over the counter equity securities. An OTC security is any stock that does not trade on Nasdaq or a national securities exchange. OTCBB stocks include national, regional, and foreign equity issues, warrants, units, American Depositary Receipts and Direct Participation Programs.
The OTC market was started in June 1990 on a trial basis as part of a wide range of market reforms that were taking place at the time. The aim of the market reforms was to make the OTC equity markets more transparent. The Penny Stock Reform Act of 1990 mandated the U.S. Securities and Exchange Commission to institute an electronic system that would abide by the rules of Section 17B of the Exchange Act. The purpose of the new electronic system was to enable the spread and circulation of price quotes and trade transactions. Starting December 1993 firms have been required to report trades in all domestic OTC equity series through the Automated Confirmation Transaction Service (ACT) within 90 seconds of the transaction. This system enables anyone form the largest firm to the smallest investor to know how many trades are taking place in a stock, the direction of the trades, buys or sells, and the volume in real time.
In April 1997 the Securities and Exchange Commission approved the operation of the OTCBB on a permanent basis with some modifications.
Even up to that point OTC quoted companies were not responsible to file quarterly and yearly financial reports. Due to the lack of the reporting requirement it became increasingly difficult to research a company. Many companies traded without having to file any financial information. An investor would have to rely on press releases and communication with the company for all information. It became very difficult to verify a press release since the releases were vague and left allot to the imagination. A company could issue a release saying that they grossed $15 million dollars in the third quarter. Now that number sounds exciting but we do not know what their expenses were for the quarter. We also do not know the size of the company’s debt, or even when the debt needs to be paid off. Many investors would see the release and jump to conclusions only to find that the company sent out another release later on announcing that they had a severe cash flow problem and were looking for to raise funds. The flip side also took place where many investors stayed away from what could have been a lifetime opportunity due to the lack of information. Many companies issued positive releases but were ignored by investors who could not find the financials they were looking for. Keep in mind that many companies today that trade for over $50 once traded for under a $1, including Microsoft, MCI, Toys R Us, and many others.
To alleviate this issue the Securities and Exchange Commission approved the OTCBB Eligibility Rule. The Eligibility Rule dictated that all non-reporting OTC companies already trading on the OTC market would have to report their financial information to the SEC, banking, or insurance regulators in order to meet eligibility requirements. A phase in period was set for all trading companies starting in alphabetical order from the beginning of July 1999 to June 2000. As the phase in date for a company passed if the company had still not reported its financials the ticker symbol would receive an extra e added. A symbol would now carry an extra e at the end letting investors know that the company had not reported its financials. The non-reporting company was then given 30 days to report. If the company did not report in that 30 day grace period the stock was delisted from the OTC and moved to the pink sheets. (We will discuss the pink sheets in the next chapter.) The benefit of this rule is that as of now any stock traded on the OTC market has publicly available financials. The financials can be accessed through Edgar or through other financial databases. The benefit of this is that in the past a company might have been able to work in the shadows without limited oversight. The company could put out ambiguous press releases with little concern over the accuracy of the announcements.
Now that every OTC company needs to file financials with the SEC they are forced to hire accountants and lawyers who are familiar with all the requirements. The management of the public company will go out of its way to make sure that its financial statements are accurate and precise. The SEC would not hesitate to suspend trading in a stock that it suspected of fraud. A suspension would be the smallest of their problems since the SEC would not let any a company off the hook if it participated in fraud. The bureaucrats in Washington realize that the reason so many international and domestic investors participate in our public markets is because of the high level of trust they have over the efficient and honest structure of our markets. Every time a company is engaged in fraud the luster of our markets faces the risk of being diminished. The SEC knows this and is therefore very strict when it comes to reviewing and accepting financials.
The strict requirements imposed on public companies are quite advantageous for the average investor. Instead of having to guess the condition of a financial company all the investor needs to do is call the company and request their latest financials. The company then has the obligation to open up its books and ensure that the investor has access to its most current filings. And now that the deadline has passed for all public companies to be fully reporting the investor can be rest assured that any OTC traded company is filling. The first step in analyzing a company is to take a step inside and pretend that you are its auditor. By printing out a copy of the company’s financials you will now know just as much about them as their own auditor. That is as long as you learn how to read the financials.
The following are some basic statistics concerning the OTC market. The OTC Bulletin Board market provides access to over 6500 different companies. It is estimated that one third of them will remain on the OTC market after meeting the eligibility requirements. As is often the case, many of the companies that do not meet the requirements and are moved to the pink sheets will file at a later point in an attempt to move back to the OTC. The OTC market consists of more than 400 Market Makers.
The Market Makers are the dealers who compete to buy and sell your shares. They set their own bid and asks for the stocks traded on the market. A typical Market Maker will set his bid at .24 and his ask at .26. He will buy shares from investors at .25 and sell them at .26. Now you might wonder what would prevent an MM from setting his bid way below the ask so he can derive a greater profit from the spread. Many Market Makers do try to widen the bid and ask as much as they can since they are looking to profit from the difference between the bid and the ask, what we call the spread. While a Market Maker chooses how he wants to set the spread he will have competitive pressures. If one MM decides to keep his spread at .02, another Market Maker might jump in an decide that he is willing to keep his spread at only a cent. The brokers will route their orders to the Market Maker with the best price. So the second MM will now receive the order flow from the brokers. Now the second Market Maker has set his bid at .25 and his ask at .26 it means that investors selling their stock to this Market Maker will receive one cent more then if they had sold to previous MM. Now what often occurs is that one Market Maker might be more interested in buying than in selling. He will raise his bid but keep the ask the same. You will see the bid raised to .255 and the ask will remain at .26. Or another Market Maker might enter the fray and realizing how much of a demand there is for the stock he will raise his bid to .27 hoping to buy up all the shares available. Why would he do this? He might be convinced that the stock will soon be trading at .30 due to the high demand building up. He will then raise his bid to .27 and his ask to .28 so he can sell his shares for a profit. Now the other Market Makers have a choice, they can either hope that the other Market Maker stops buying shares and lowers his bid and ask or they can match his price. If they do not match his price then all the buys and sells will be directed to the new Market Maker who is offering the best price. Like in the real world, all the sellers will now sell to him since he is willing to pay the most. Now the other Market Makers will watch the activity very closely. If they sense that the availability of shares is drying up they will be forced to move up their bid so they can also buy stocks to resell later on. Very often this happens so fast that the Market Makers are caught off guard and do not have any shares to sell to the public.
They will have to rapidly increase their bids so they can buy shares. They are most likely selling shares they do not have in their hands in the hope that they will be able to buy them later. But until they can find sellers from whom to buy the shares they will have to keep increasing their bid. They also raise their asks in tandem with the bids so they can sell the shares they are buying to the ravenous buyers. When the amount of shares (the supply) is smaller than the number of buy orders (the demand) the price rapidly increases. Most OTC stocks trade for under a dollar and never experience any large publicity. But once they do experience a moment in the spotlight you will see many, sometimes thousands of investors, rushing to buy the stock. But since the float of the stock might only consist of 1,000,000 shares there will not be nearly enough shares for all of the buyers. The Market Makers will want to buy and sell the stock since they make their money in stocks experiencing large amounts of volume. They will set bid and asks for the stock hoping to be able to buy and sell the volatile stocks. But the only way for them to keep up with dramatic surge in volume will be to raise their prices as much as they need to in order to buy stocks from the public. They will also raise the price they are willing to sell their shares to the buyers when they determine how much the buyers are willing to pay for them. I have seen many stocks issue positive news and then have the price of their stocks double the same day. The floats were often small and the investors felt that the stock was worth many more times than what they paid for it. I have also seen stocks like EPWN move from .09 to $8 in four months on a steady release of positive news. The Market Makers make money regardless of the price of the stock since they will always sell it for less than they buy it and buy it for less than they sell it. The difference between the OTCBB market and the Nasdaq is that OTC companies do not have listing standards. The Nasdaq has very strict qualifications for letting a company list its stock on its exchange. The OTC allows any company that files its statements to trade on its market. The Nasdaq requires a company to meet asset and revenue criteria while an OTC company does not need to have any assets or revenues. Many Nasdaq companies that fall into financial hardships are often removed from the Nasdaq due to their inability to meet listing requirements. They might have either lost a large percentage of their assets or revenues and are most likely in bankruptcy proceedings. Once their share price falls and stays below a certain price thresh hold for an extended period they are removed from the Nasdaq and then resume trading on the OTC market. The most important difference between them is probably that the OTC market does not provide automated trade executions. It is up to the Market Maker to decide if he wants to buy your stock. He can sit and wait and watch the direction of the market or he can simply decide not to buy it. Chances are that if a Market Maker does not act on an order the brokerage house will stop sending trades in his direction. Once a Market Maker develops a reputation for not acting on orders in timely fashion the brokerage houses will choose not deal with him. What a Market Maker will do when he does not want to act on the order is that he will change his price. If he does not want to buy your BICO for .22 he will lower his bid for .21. This way he does not appear to be ignoring the order. He is also hoping that you will lower your price until he decides to buy it. He can keep lowering his bid until he decides that the stock is now cheap enough for him. After buying your shares he will raise the bid if he has to buy more shares from other investors. The Market Maker will not do this if there is allot of volume since in that situation he would just want to be able to quickly buy and sell your shares. But the above does happen when you are dealing with a stock with minimal volume. If you are the only sell that day and there have been no buys the Market Maker will not be in a rush to buy your shares since he will most likely be stock with the shares for a while.
Investing and trading in penny stocks is potentially highly rewarding but also tremendously risky. The purpose of this book is not to recommend penny stock investing or trading to anyone. The book is written for people who have already decided that they want to invest and trade penny stocks. The book is meant to educate those people who have already made the decisions. I also would like to convey that investors should make their own decisions and realize that I am not an investment advisor nor am I giving investment advice. This book is not written in any advisor capacity. The book is meant only as an educational book. I have made and lost huge amounts of money in penny stocks. When I first started investing in penny stocks three years ago I lost 80% of all the money in my account within the year. You might not be so lucky.
If you still want to invest in and trade penny stocks you should start out with a small amount that you could afford to lose. This way if you lose the money you will not suffer. And if you do find a real winner, your investment should still be able to grow significantly.
You should discuss anything you read in this book with an investment advisor before you act on it.
Okay, now that I have scared you and made you regret getting exited about penny stocks in the first place let me leave you with some optimistic words. You can be successful at anything if you put your heart into it and work hard. You need to persevere even when it is difficult and the road seems to be too much of a challenge for you. I believe that penny stocks, like other financial and business ventures, require an enormous effort and hard work. I also believe that the hard work and effort will pay off to those who commit themselves to being successful.
I have one final note. The year that I lost 80% of my account was followed by a 1000% gain in my account without putting a single additional dollar in my account. God’s help and hard work pays off.
Copyright - Donny Lowy - About The Author
U.S. Government Required Disclaimer - Commodity Futures Trading Commission. Trading financial instruments of any kind including options, futures and securities have large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the options, futures and stock markets. Don't trade with money you can't afford to lose. This training website is neither a solicitation nor an offer to Buy/Sell options, futures or securities. No representation is being made that any information you receive will or is likely to achieve profits or losses similar to those discussed on this website. The past performance of any trading system or methodology is not necessarily indicative of future results. Please use common sense. This site and all contents are for educational and research purposes only. Please get the advice of a competent financial advisor before investing your money in any financial instrument.