All about investment

Peter Leeds

Have you ever wondered why a penny stock falls sharply in price right after it achieves a major


There's an expression in the stock market that says, "buy the rumor, sell the fact." The idea is simple. When there's an outstanding rumor about an upcoming event for a company, investors buy in, thus pushing penny stock share prices higher. Once the event itself is actually realized, the share price loses that upward buying pressure, and the penny stock drops in value.

For example, ABC Inc. is likely to get FDA approval for their new drug. The upcoming ruling is widely expected, and many investors buy in, speculating that the announcement will send the shares skyward. This starts pushing the penny stocks' price up.

Once the actually FDA approval is officially granted, the shares don't spike much higher since the speculators had already run the share price up so much. Now that the announcement is out, many of those same speculators start cashing out, putting a great deal of selling pressure on the stock.

The following events are some examples of what might drive buying interest:
• impending patent award
• expected strong financial results
• new major customer or contract win that is widely anticipated
• upcoming release of a new version of their technology
• anticipated FDA clearance

Any such widely anticipated event would gradually push share prices higher. The penny stock would gradually increase, higher and higher, until the underlying event finally came to pass. Then speculative buying vaporizes, sellers come out of the woodwork, and shares start their descent.

For this effect to actually occur, the rumor or event needs to be:
• widely known
• growing in probability
• noteworthy (potential for a major impact)
• nearing the date it's expected to occur

"Buy the rumor, sell the fact," plays out again and again on the markets. It's certainly not the exception, but rather the rule. Keeping this in mind will help you identify penny stocks that may trend upward, allowing you to ride the shares up for profits. Just make sure to escape your position before they come crashing back down to earth, and more realistic valuations. In other words, buy the rumor, sell the fact.

Putting your money on companies with big market capitalizations is often touted as one of the safer ways to invest in stocks. After all, these blue chips and mega cap companies are generally stable, secure, and are well-known industry leaders. They are traded on major exchanges such as Dow Jones and Nasdaq and are widely covered by the media. Thus, investors can easily get their hands on a wealth of corporate information about these companies. Clearly, playing with the big boys in the stock investment arena has its perks.

For the stout-hearted and adventurous investor though who can handle much higher risks, micro cap companies are worth looking into. Micro caps, also known as penny stocks, have market capitalizations of $50 million to $300 million although some companies can have as low as $6 million in tangible assets. They often trade for less than $5 per share but this range fluctuates depending on market performance. Penny stocks could outperform large and small cap stocks by as much as three percent. Because of their low stock prices, these stocks are quite attractive to retail and novice investors.

Micro cap stocks are traded on the Over-the-Counter Bulletin Board. While companies listed in the major exchanges need to meet minimum requirements such as net assets and number of shareholders, penny stocks are not subjected to any listing standards. The Securities and Exchange Commission requires micro cap companies to file financial reports except for those with less than $10 million in assets. These are helpful sources of information for investors although the accuracy and timeliness of the reports could at times be disputed.

Micro cap stocks are generally not covered by mainstream media and analysts which makes it difficult to obtain information about these companies. Investors must then do their own research. Relevant factors to look into are the 52-week high/low trading range, the price/earnings multiple, and the net profit and cash flow. Note also if the company files its financial statements on time and on a regular basis.

Most companies in the micro cap range aren't raking in major earnings yet and may take a long while to do so. The key is to study a company's business model and to be aware of any potentially marketable product or technological innovation that it plans to launch into the market.

Investing in micro caps requires a lot of effort in research and patience in waiting for the company to develop. Penny stocks have relatively low liquidity and as such, cannot be sold quickly to minimize losses should things go wrong. A lot of micro cap companies also tend to have short life spans and could fold up anytime.

The market of penny stocks is also teeming with fraudsters who illegally profit from unsuspecting investors. Unscrupulous brokers would buy stocks from a micro cap company at very low prices and re-sell them with an outrageous mark-up. Some micro cap promoters also create hype about a certain company to start a buying frenzy and increase the stock price. The overvalued stocks would eventually plunge back to its penny price once the hype is over and consequently wipe out the investors' money.

About the author:
Kristien Wilkinson is an online writer and contributor to http://www.tradingstocks.com