These stocks are fraud factories, nothing more

14,849% Profits in Red-Hot Penny Stocks! Or Go Bankrupt

Have you ever heard of Save The World Air, Symbol ZERO? a reader recently wrote. It’s a penny stock (that) just went from 28 to 40 cents any comments whats up?

The short answer on this penny stock investment: Whats up is rampant speculation. Not news, not fundamentals, not charts. Speculation.

This is true for any microcap pink sheet stock. You’re better off buying a lotto ticket than these things.

To be clear, not all pink sheet stocks are penny stocks . Some are legit multinational companies. Nestle (PINK:NSRGY ), one of the biggest consumer brands in the world that trades as a pink sheet, as does Japanese car-maker Nissan (PINK:NSANY ). Other big names include Swiss drugmaker Roche Holding Ltd. (PINK:RHHBY ), German utility E.ON AG (PINK:EONGY ) and automaker Volkswagen (PINK:VLKAY ). (Heres a previous article on how to find responsible profits on the pink sheets )

But true penny stocks with a small market cap, low volume and a share price of less than $1 are not legitimate investments. Why? The issues surrounding risky penny stocks are myriad, but heres a short list:

Many have shoddy operations. Penny stocks trade over-the-counter or as pink sheets because they cant qualify for major exchanges. But even in the unregulated realm of OTC bulletin boards, penny stocks are regularly suspended from trading by the SEC because they dont do simple things like file regular reports. Take a look at this list of six penny stocks suspended on Jan. 25 by the SEC for delinquent filings. Many of these stocks trade off major exchanges like the NYSE or Nasdaq for a reason.

Fraud is too common. Enron cooked the books brazenly to fool investors, but if youre a small outfit, all you have to do is come up with a few hundred grand here and there to drastically inflate sales and profits. Check out the most recent SEC litigation report for tales of creative accounting at Oak Hill and InPhonic. The temptation is too large for many corrupt CEOs or investors in pink sheet stocks. Furthermore, didnt you hear about the mythic Daniel Ruettiger, the Rudy football walk-on of Notre Dame fame, getting nabbed for a pump-and-dump penny stock scheme. Wait a few weeks and even more brazen tales will surely emerge.

Ultra-low volume comes with high risks: Lets assume Save The World Air is not just an overly dramatic name for a useless pump-and-dump scheme. Maybe this company will indeed save the world from pollution someday though forgive me if I remain skeptical that technology is coming from a no-name penny stock. Anyhow, even if this pick is legit, it still can suffer wild swings thanks to low volume and investor sentiment. Theres no safe way to control volatility like these because you can be whipsawed around, stopped out for no reason or charged an arm and a leg to buy new shares if you dont use a limit order.

Scam Newsletters. I know, I know, you might think many paid newsletters are scams and think even legit publications by Jim Cramer et al are nothing but overhyped marketing. Ill admit that many overpromise and underdeliver, and suffer from a lack of transparency. But Ill go out on a limb and say that even Jim Cramer was never stupid enough to act like he could deliver 14,849% returns in a single trade. Of course, hes not psychic, either so thats probably why.

In summation, dont believe the penny stock hype. I can’t tell you how many investors have lost big money on microcaps like Save The World Air. Thin-volume Hail Mary plays like this are great if you pick right but can really burn you on no news and for no discernible reason.

You might say fraud, insider trading, volatility and the prospect of losses are all inherent to equity investment so why single out penny stocks?

Well, investing is about limiting risk as well as maximizing rewards. And the risk is too high in penny stocks. If you want to play that game, go ahead. But recognize what youre getting into.

Jeff Reeves is the editor of InvestorPlace.com. Write him at editor@investorplace. com , follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook . Jeff Reeves holds a position in Alcoa, but no other publicly traded stocks.

investorplace.com/2012/01/red-hot-penny-stock-investing-scams/.