Stick with NYSE and Nasdaq stocks priced $5.00+ – Listing requirements vary, but NYSE and the Nasdaq have the highest – better protection against misrepresentation or fraud. Foreign stocks can also be listed on NYSE or the Nasdaq, provided they meet the listing/reporting requirements, in the form of ADR (American Depositary Receipts) or ADS (American Depositary Shares), offering direct access to some of the hottest foreign markets like China and India.
The lower a stock’s price, the faster it can move in either direction because any stock can move a buck a day, and a buck is a buck; but it’s a 20% move for a $5.00 stock and only a 2% move for a $50.00 one. Stocks priced below $5.00 are more likely to be subject to manipulation and may not be marginable.
Low priced stocks seem to have an irresistible allure for novices who look at the long-term chart of Microsoft and go: “Had I bought this stock 20 years ago when it was selling for pennies, I would be rich by now!” So they set out on a search for “the next Microsoft” they can load up on for pennies today. The problem is: Microsoft never traded for pennies. The price has been adjusted for stock splits. If anything, Microsoft seemed too expensive to most when it was hot.
Another common way to bring small cap stocks to market is through a reverse merger when a privately held company (foreign or domestic) buys a US listed shell – a public company with no operations whose stock sells for pennies, and merges itself into it, assuming its identity and thus becoming a publicly traded company. The operations of the acquiring company now “fill” the shell. The principals can sell their shares to US investors and raise capital. This cheaper alternative explains how many hot Chinese stocks have appeared seemingly out of nowhere on traders’ radar screens.
Avoid Penny Stocks, BB (Bulletin Board), and PK (Pink Sheets) Stocks
As the name suggests, penny stocks trade for under $1.00.
If a stock does not meet the general NYSE/Nasdaq requirements, it can still be listed on the Nasdaq’s Bulletin Board or in Pink Sheets (as indicated by the .OB or .PK upended to the symbol accordingly.) Don’t go there. Due to limited reporting/disclosure requirements, these stocks are rife with fraud and manipulation.
The most typical form of manipulation is pump and dump, where an operator buys a lot of low priced .OB/.PK shares in a low float stock and then pumps it up on message boards as the next big something: “about to get a huge Federal contract, discover cure for cancer, launch a new killer product,” etc., causing the price to rise dramatically in a short period of time, thus attracting naive investors. Once the stock has been pumped up to an unsustainable high, the operator begins to dump – sell the marked up stock to enthusiastic simpletons. Most buyers end up bagholders – buying high (during the pump) and ending up with a sudden loss after the dump.