Penny stocks are an attractive investment mainly because of their low value. These penny stocks are priced at less than $5. Many mainstream investors and investment institutions keep away from penny stocks. The primary reason is the number of frauds and scams that occur in penny stocks. So as an investor, one must know the pros and cons before investing.

There are many hidden gems among these penny stocks. Many legitimate companies that are starting out their business are good examples. They may be genuine companies with sound business fundamentals and these companies will definitely make it big in the long run. One of the finest example is a stock called Arcelor Mittal that traded, a few years ago, at just $0.89.

From there it shot up to $104 in 2007. People who invested in this stock made millions of dollars. There may be many more such companies in the market today. The trick is to find a company with a good profit-making potential for penny stocks trading.

On the other hand, penny stocks trading is an area where frauds and scams happen very frequently. This is mainly because the value of these shares are so low and they are also very thinly traded.

This gives rise to manipulations in the stock price. A typical fraudster will buy a lot of shares of a company. Due to its small volume, the value of the shares will go up. Any investor who believes that this is genuine will try to buy more shares and this will further increase the value of the stock.

The fraudster would make a handsome profit with the difference and after this, he or she will sell the shares. This will bring the value crashing down. Investors who invested in these penny stocks will stand to lose a lot of money, sometimes even the entire capital. Because of this nature of penny stocks, one must be very careful while investing.

Extensive research is the cornerstone of penny stock investing. Every investor must thoroughly examine the background of the company and its ability to be profitable in the long run. Some of the other factors that can also be considered are the past performance of the company, its profit earning or growth earning ratio, the competitiveness of the company in its industry, the ability of its management to turn things around for the company, and finally the soundness of its fundamentals.

But the main problem with penny stocks companies is that these information are not readily available because they do not have to follow the regulations laid down by SEC with respect to the public disclosure of its financial statements.

An investor can obtain information about the company from his or her brokers, the prospectus at the time of filing for Initial Public Offerings (IPO), trade confirmations, and manuals issued by agencies like Moody's and Standard and Poor and from periodic reports filed at the Securities and Exchange Commission (SEC). The most important report that one should look for is the 10-K report.

In short, an investor can make a lot of money in penny stocks trading provided the right company is chosen.