Most penny stocks are traded by a group of brokers or brokerage firms that are also market makers, so it's easy for them to manipulate share prices. When these firms acquire a large number of shares at a low price, they can create an artificial demand to drive up the price. The price of these penny stocks may not reflect the true value of the company but the simulated demand created by aggressive marketing.

Another risk with penny stocks is that the spread is often very large, resulting in immediate losses for the investor. The spread is the difference between the selling price and the buying price of a stock. If, for example, you bought penny stocks for 20 cents, but the brokerage firm is only willing to buy it back from you for 10 cents, you would have an immediate paper loss of 50%.

Know the signs of penny stocks fraud

1)Many fraudulent brokerage firms make unsolicited telephone calls nationwide to as many persons as possible. If you encounter these types of calls, hang up.

2)A broker may pressure you into buying penny stocks by saying he/she has inside information on this particular stock and that you should purchase it before the information becomes public

3)A broker may offer you penny stocks at below-market prices, but will convince you to purchase within 24 hours to avail of the special price

4)A broker may tell you that the price of a particular stock has been rising for consecutive days, and that you should purchase right away, before the stock rises even further

5)A broker may tell you that he/she has been informed that there is only a limited amount of stock available at the current price so you should but it immediately

6)Some fraudulent brokers may purchase penny stocks for you based on your intentions alone. Such purchase or sale made in a customer's account without specific instructions from that investor is illegal.

Safeguard your investment

1)Always protect yourself against unauthorized transactions. Unless you fully trust your broker, never give out personal information such as your social security number, your financial condition, your past investment history, or your bank, credit union, or savings and loan references.

2)Make sure your penny stocks broker is registered with the Securities and Exchange Commission (SEC) and licensed to operate in your state. Find out about the firm's past dealings or if it has a history of disciplinary action from regulatory boards.

3)Get as much information about the company you're investing with. Ask your broker for a written copy of the company's financial statements. If the broker hesitates in providing you with such information, it's probably time to walk away.

4)Monitor stock prices. You can ask your broker to send you written copies of price predictions and prospects for the company. It is always a good idea to seek independent opinion from other brokers, bankers, or people you trust who are knowledgeable about financial matters.

5)Look for penny stocks that have a bid price that's close to the ask price.

6)Trust your instincts. If a penny stock investment opportunity sounds too good to be true, it probably is.

7)Before spending your hard-earned money, check out the investment carefully. Do not rush a sale because your broker tells you that you cannot afford to let this opportunity pass. Other investment opportunities will come along, but money lost to fraudulent brokers is gone forever.