How do 1 cent stocks work
Penny stocks: how supposedly cheap stocks hurt investors
If you are not familiar with the term “penny stocks”, here is a brief explanation: Penny stocks are stocks that have prices in the cent range. This means that the corresponding shares on the stock exchange cost less than, for example, 1 euro or 1 US dollar.
Unfortunately, this often suggests to investors that the shares are particularly cheap and also offer higher price increase potential than shares that cost 100 euros or 100 US dollars on the stock exchange, for example. This psychological effect just described is also one of the main reasons why companies listed on the stock exchange carry out stock splits.
In the case of a stock split, the number of shares is increased and the share price is thereby reduced. Fielmann is a recent case. Since the Fielmann share had passed the 100 euro mark and thus looked expensive, Fielmann carried out a share split.
Fielmann doubled the number of shares, which reduced the price by half to around 50 euros. We will go into more detail on the subject of “share splits” in one of the upcoming issues. However, there is one thing I would like to reveal to you right now: Share splits do not have a negative effect on you as shareholders.
Now we come back to the penny stocks: The probability that a share will rise from 10 cents to 1 euro appears to be significantly greater than the probability that a share will rise from 100 to 1,000 euros, although the percentage increase would be identical in both cases .
It is a fatal misjudgment that has already cost many investors a lot of money because fraudsters take advantage of this psychological error. I would now like to briefly introduce you to a real case from this year.
The spectacular case of fraud involving the US stock Cynk
A spectacular price development recently caused a sensation on New York's Wall Street. The share of the company Cynk made a meteoric rise in price and rose within a very short time from 6 US cents to 21.95 US dollars. This corresponds to a price increase of an incredible 36,483%.
The market value of the former Penny Stock had risen to 6 billion US dollars within a few weeks. But then the American Securities and Exchange Commission (SEC) put an end to the hustle and bustle.
Specifically, the SEC stopped trading Cynk shares on suspicion of manipulative transactions. In other words, the SEC believed there were fraudsters at work. After trading in Cynk stock resumed, the stock price eventually collapsed.
This is how easy the penny stock scam works
But how did the market value of a company with just one employee, no assets, and no sales rise to $ 6 billion? Quite simply, scammers have done two things that have aroused greed in many investors. You initially spread false reports in a targeted manner, suggesting that the Cynk share was about to make gigantic price jumps.
In the second step, the fraudsters covered themselves up with Cynk shares and thereby triggered a first price jump. How it works? In the case of stocks that are hardly traded (one also speaks in this context of stocks with a narrow market), even small changes in demand are sufficient to cause price jumps.
In other words: If there is hardly any supply and demand in connection with a share, but the demand suddenly increases, the price of the share also rises significantly as a result. The combination of reports suggesting gigantic price rises and actual first price jumps then ensures that greed is aroused in many investors.
And since greed is known to eat brains, the investors who invested in Cynk shares with their greed have not noticed that the company does not even have its own website. Now we come to how the fraudsters make a fortune with their scam: Since the fraudsters had previously stocked up on Cynk shares, they benefited from the gigantic price increase.
And because the demand for the Cynk shares was huge at the peak, the fraudsters had no difficulty in getting rid of their previously cheaply acquired shares at completely inflated prices. Because the suspicion of fraud finally arose, the share was then suspended from trading and as a result no one wanted it anymore, those investors who had only recently got in have lost a lot of money.
They became victims of their greed. Incidentally, this scam is called “Pump and dump”, which in German means “cheering and repelling”. The prices of the penny stocks are first cheered and then the fraudsters sell their previously acquired shares with correspondingly high profits.
The US regulators tighten their requirements and German brokers and direct banks are reacting
Such cases are unfortunately not uncommon both in the USA and here in Germany. Most recently, the US film "The Wolf of Wall Street", which is based on a true story, also addressed this scam. But now the US authorities want to take action against it and are therefore tightening their requirements.
As part of the US Money Laundering Act, regulators are also investigating penny stocks on Wall Street. As part of the Anti-Money Laundering Act, these companies and their investors are being scrutinized more closely by the supervisory authorities. The US custodians of many online brokers and direct banks in Germany responded to this.
In response to the stricter requirements imposed by US regulators, they introduced changes to the custody and tradability of certain securities on US trading venues. As a result, institutions such as Onvista Bank, DAB Bank and ING-DiBa had to restrict trading in speculative US values.
Onvista Bank has informed its investors that trading in some penny stocks will have to be stopped. The restrictions imposed by the US authorities are intended to reduce the number of cases of fraud. At least the possibilities of “pump and dump” are intended to be significantly restricted.
Conclusion: negative examples and the US authorities should protect you from such scams in the future
For you as a private investor, the restrictions imposed by the US authorities are not a disadvantage. On the contrary: it protects you from potential fraudsters. The case described in this issue of the fraud involving Cynk shares is intended to offer you further protection.
Because if you know how a scam works, you should be less likely to fall for it. Finally, a basic tip: Try to block out emotions as much as possible when it comes to investing. This will prevent you from being guided by greed.
Fielmann shares remain an attractive long-term investment Fielmann intends to continue its steady growth in the future. In addition to good price opportunities, the share also offers an attractive dividend. > read more
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