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Penny Stock Red Flag Checklist

Here is a listing of Penny Stock Red Flags. These are generally signs of bad things ahead for a stock. While they may not always pan out to be true, in most cases a penny stock with these red flags is a hazard to your portfolio. The more red flags, the worse. Bookmark this page and come back to review the checklist for every new stock you trade! Please make any suggestions for additions/changes here

NEW! For more details on any item on the list simply hover your mouse over the question mark.

A: Signs of a Scam

1. Lack of communication from the company. More Info
2. No verified/legitimate physical place of business. More Info
3. Incomplete/unprofessional looking website with very old updates, or used for direct shareholder communication. More Info
4. Brand new flashy website and corresponding PR, both providing only bits of vague information. More Info
5. Company officers/employees involved in other penny stocks. (hint: use google) More Info
6. Over-optimistic, hype filled, "too good to be true" statements from the company. More Info
7. Press Releases (PR's) with vague, inconclusive language, insubstantial details, and/or no hard numbers. More Info
8. Multiple PR's in a day, week, or other short period of time falling into the category above. More Info
9. Business models or products that just don't seem "right". (hint: ask yourself, "Would I buy this?") More Info
10. No follow-through on promises by management, eg. financials, share structure updates, uplistings, etc. More Info
11. A company that seems focused on the stock price and not the business. More Info
12. A pinksheet holding company with no actual owned holdings. More Info
13. A company that changes its business entirely, eg. going from petrified wood salvage to lottery machines. More Info
14. A company that pops up quickly into a newly hot business sector, often world news related. More Info
15. Employees immediately dumping stock received through a compensation program. More Info
16. A history of company name changes, symbol changes, and reverse splits. More Info
13. Incessant Dilution - See Part B. More Info

B: Signs of Dilution

1. Gagged Transfer Agent (TA). More Info
3. Inability to get a current share count from the company. More Info
2. Increasing Outstanding/Authorized share counts. More Info
3. Constant decline in price with rapidly increasing volume on chart. More Info
4. Decline in price with no material event as a cause. More Info
5. Large, even blocks of shares continually hitting the bid. More Info
6. A history of Reverse Splits after running the share price into the ground. More Info
7. The opening of a 504 Reg. D program. More Info
8. Convertible debenture programs disclosed in financials or company communication. More Info
9. Heavy coverage by penny stock promoters , mindless pumping on message boards, spam emails. More Info
10. History of pump and dump action on the chart. 1-3 day quick runs followed by steep high volume drops. More Info
11. Blaming low price and decrease in price on Shorting and Market Makers (MM's). More Info
11. Several signs of being a scam - See Part A. More Info

C: Signs of a poor stock for trading

1. Very low volume.. remember to think in Dollar Volume. More Info
2. Long periods of time (both short and long term) with little to no volume. More Info
3. Large spread between the bid and ask prices. More Info
4. Large, sporadic changes in price on low volume. More Info
5. A stock with a long term negative trend. More Info
6. A broker restriction on buying/selling the stock. More Info
7. A history of halted trading. More Info
8. Long waits to get your orders filled. More Info
9. Signs of being a scam or being plagued by dilution - See part A and B. More Info

Please make any suggestions for additions/changes here


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Last Updated: 10/18/10

A company that might be a scam, and looks to be diluting probably does not have a good stock to be trading. While quick profits can still be made when these stocks are in pump mode, always remember to secure profits quickly. The price drops on these stocks can be very painful when the music stops!
If it takes a long time for a buy order to fill, be prepared to wait for your sell order to fill. Not being able to move easily in and out of a stock is not a good thing for trading. Be careful and get your orders in early.
Halts are not a good sign. The SEC sometimes halts stocks that have very quick and large moves that could be caused by manipulation or insider trading, or when a company is suspected of misleading investors. If the company has a history of halted trading with their stock, make sure to do your DD to find out why.
Sometimes a broker will place a restriction on a certain stock requiring clients to call in orders to buy. While there may be no legitimate reason for the restriction, it will probably deter others from buying, and reduces the chance of any price appreciation.
You have to mind with the trend when trading stocks. Picking the bottom on a stock is very difficult. A stock in a decline will most likely decline further. A stock in an up-trend, however, has better chances of continuing upward. Try to find the ones in up-trends.
A volatile, low volume stock might be good for a quick trade, but can also leave you with a steep loss very quickly. Be prepared to hold your shares, or sell at a discount if you get stuck.
A large spread, often accompanied by low volume is indicative of low investor/trader interest. Again it will be very hard to move shares with this kind of stock.
For the same reason as above, if there are long periods with little or no trading, it could be impossible to get in or out of the stock, or you may have to pay a big premium, or take a big discount to do it.
Low volume does not translate to an easily tradable stock. Think in 'dollar volume' - the actual value of shares traded. If the volume is low it can be very hard to get in and out of the stock especially at a decent price.
A scam company is almost always interested in dilution.. this is often their only method of making money to begin with!
Companies, as well as investors/traders are often known to blame poor price action on shorting or market makers, or both. This is used to persuade investors that the company isn't diluting, while in reality it is the dilution that is causing the poor share price. We are not saying that MM's or shorts never cause harm to stocks, but in reality we believe it is more often dilution, or plain and simple supply and demand that causes poor or erratic price action.
See the previous tooltip.
Companies will often use and pay for penny stock promotion services, which in turn use newsletters, message boards, advertisements and even spam to get investor/trader attention. This pumps the share price up and allows the company to sell shares in order to raise capital. The promoters may also have been compensated with free shares. When the promotion, or pump, is up, the share price will often collapse. While these methods of investor awareness can be used responsibly, they are most often abused, with the shareholder being left with a loss.
Convertible debenture programs, or sometimes CD's for short, are agreements between the company and an investor. The investors provides capital to the company, and the investor is then compensated with shares to cover, and make a return on the investment. They are often given discounted shares, that are in turned sold on the open market. Some agreements can be very harmful to share price, as they can amount to a plethora of shares being sold in order for the investor to make their money back.
A Reg. D 504 program is a method for a company to sell securities (stock) without having to register them with the SEC. Rule 504, specifically entitles a company to sell up to $1,000,000 worth of shares within a 12 month period of time. This is, by definition, dilution. A 504 could cause significant harm to the share price if buying demand is not high enough. Click the question mark for more info on 504's.
A company that has a history of pumps, dumps, and subsequent reverse splits is most likely a scam, and is also most likely diluting at any opportunity. Click the question mark for more information on reverse splits.
Sometimes you will see large even blocks hit the bid, or be sold at the ask when dilution is occurring. The size of these blocks depends on the stock price, but 10K, 50K, 100K, 999,999 or 1M size blocks are common. Keep in mind these could just be large orders from traders/investors, but if you start to see a lot of them, and the price is suffering or behind held back this could be dilution.
If the price is continually going downward with no material event (news, filings, world event, sector action), dilution may be occurring. If the decline is after a large run-up in price it could just be the selloff and return to equilibrium. If it is out of the blue from a relatively stable price level, it could be dilution.
If the price action of the stock is continually downward, with a corresponding rapid increase in average daily volume, there is a chance that dilution has, and may be still occurring. In this case the dilution is what caused the decline in price, and the increase in average volume is due to the fact that more shares are outstanding. Keep in mind that the higher volume may just be due to the lower price. Try to think in 'dollar volume' - the actual value of the shares traded. If the dollar volume is up substantially there could be more shares outstanding. Also look at how the volume affects the stock price compared to how it did in the past. If low volume caused large changes in price in the past, and high volume is now causing small changes, there is a very good chance dilution has occurred.
If you do have access to the current share structure via the TA or company, and the outstanding share count increasing, dilution IS occurring. If the A/S or authorized share count is raised, particularly by a large amount, dilution might be imminent. This might not always be the case, as the company may be creating a "poison pill" to prevent a hostile takeover. Often times, however, a large increase in A/S is for the purpose of further dilution. Click the question mark for more info on stock share structure.
If the TA is gagged, your only other source of share structure is the company itself. The validity of share structure info received from the company is often times very questionable. If they won't release any info, and the TA is gagged, they are most likely trying to hide dilution. Beware and only make quick trades if at all.
A gagged transfer agent, or TA for short, is not a good sign when it comes to determining if dilution is possible. The transfer agent is the only reliable source of the current share structure of a stock. If the TA is gagged -instructed by the company not to release information - investors/traders have no way of knowing if the company is dumping shares. We at believe there is no good reason for a gagged TA, and most of the time it is used to hide dilution while it is occurring. Your best bet is to stay away from stocks with a gagged TA, and if you play them at all, make it a quick trade to protect yourself. Click the question mark for more information on Gagged TA's.
A company that dilutes its share price into oblivion obviously has no regard for its shareholders, and most likely has no legitimate business other than selling shares. To figure out if a company is diluting, check out Part B!
The classic scam penny stock company pumps the stock up, dilutes it into oblivion, enacts a reverse split, rinses (changes symbol/company name) and repeats. Do some googling to find the history and avoid these repeat offenders. Also, click the question mark to check out an iHub page on reverse splits.
Some companies will use stock as a form of employee compensation or bonuses. If the shares are dumped quickly that gives you some idea as to how confident that employee is that the share price/business will remain stable or increase.
World news events can be highly influential on a penny stock. The investor attention can explode, along with the share price of the stock. Scam companies will often pop up to take advantage of the hype (hint: 9/11, SARS, Swine Flu, etc). There are also some companies that are disaster related, such as hurricane cleanup/logistics, that will often see a run-up into the beginning of the storm season, followed by a decline and dormancy into the off season. Be wary of the hype, trade it if you wish, but don't invest in it for the long haul.
A company that totally changes its business is probably just attempting to create a new "hot penny stock story" to draw investor/trader attention. Please note that the change in business could be a reverse merger which is a whole different story. A legitimate company could simply be buying and merging with a public shell in order to go public themselves.
Some penny stock companies are holding companies, and claim to, or insinuate that they are the owners of one or more businesses or assets. In reality they may own nothing at all. Normally all companies involved are publicly traded on the PinkSheets or OTCBB.
A company primarily focused on share price is most likely doing so because they want to sell shares (dilute) at the highest price possible! The primary focus should be on business development, sales and growth. While it is OK for the company to be concerned about the share price, and it's shareholders, those that are obsessed with it are probably not looking out for you as much as they are themselves. Click the question mark for more info on dilution.
CEO's of scam companies will very often make promises to investors of information to be released by certain dates. The dates come and go and nothing is ever seen. The information is just a carrot hanging in front of the investor. Financials, uplistings, audits, sales numbers are all classic examples of such information. If a company has a history of missing promises, don't expect them to get any better after you buy their penny stock.
Any seasoned penny trader has seen companies peddling, or claiming to peddle ridiculous products. Adult theme game boards, miraculous devices that double your gas mileage, etc, etc. This is not to say some of these companies had stocks that were "tradable", but be very wary about holding such a stock for any period of time.
Multiple PR's in a short period of time (especially the type above) is indicative of a company wishing to pump up their stock. Often the company will begin selling stock incrementally into each PR. When the company runs out of news to announce the stock will often drop because the sizzle is gone and there is no good reason for people to buy more shares.
A scam company will often release PR's that offer no hard details... an announcement of product orders or contracts without the number or dollar amount, using inconclusive language like "the company has initiated/intends/proposed to buy back 'up to' one million shares". Such language is used to mislead investors without technically being incorrect.
This one is pretty simple. If it sounds too good to be true.. well, you know. This type of hype is just used to get investors/traders excited and create a burst of buying pressure.
People that run a scam penny stock company are often involved in other scam companies. Do your homework to check the background of those involved in company management, board of directors, advisors, etc. Hopefully there will be some information available via google. Any time a new member is announced do some quick checking ASAP. Sometimes a company will release a PR announcing a new member in an attempt to bring some sizzle to the stock's story, when in reality that new member could be an age old scam artist from previous companies.
In addition to the above. A brand new website should raise some concern because some companies will use a new fancy looking website and PR as a means of getting investors to buy stock. Unless a company's business revolves around the website itself, beware of the flashy new website hype. Also be aware of sites put up by pumpers that claim to be, or are made to look like company published sites.
A public company should generally have a website, and if they do it should be a professionally designed and coded site. Any site that looks amateur, has very old information, or is incomplete should raise some suspicion. Some companies will also use a site to provide shareholder updates. This is a red flag in that a legitimate update should really be disseminated via a press release, or SEC filing, with appropriate safe harbor disclosures. Many scam companies will use the website to post "news" because there is no real legal binding for any of the information to be accurate.
A real company should normally have a physical business location. If none is found, the "business" could simply be operating out of a persons home with a website, phone, fax etc, and a few phony pictures of the business or related activity.
A legitimate company should be readily available for contact via phone, email, or both. A "fly by night" or scam company will often be difficult to make contact with, if you can at all.