Stock Market and Market makers

A market maker is a broker-dealer who stands ready to buy or sell 100 shares of the stocks in
which it makes a market. When a transaction is proposed, the market maker will give a price at
which it would be willing to effect that transaction. The market maker’s price applies only to the first 100 shares. While the market maker system has been widely criticized (after all, how much of a commitment is it to buy 100 shares at a penny apiece?) the system does offer investors some
level of fairness. The more market makers there are in a given stock, the more likely they are to bid against each other, and the price will more likely move to a true “market” price. The names of the market makers of securities traded in the pink sheets are listed in the pink sheets.


Especially when there are few or only one market maker, penny stocks are susceptible to price ma-nipulation. A common and easy manipulation is for a broker-dealer to gather a large holding of a penny stock at a very low price. Through the use of high-pressure sales techniques, the sales force of the broker-dealer hypes the stock and stirs up demand, which seemingly justifies the continual rise in prices given by the broker-dealer (which is probably also the only market
The price continues to rise until there are no more investors who will buy, and then the bottom alls out and the price plummets. Sometimes the broker-dealer will buy back the
securities at the fallen prices to recapture the stockpile for a future revival of the stock; more often investors are sim-ply left holding the worthless stock.

Initial public offerings

The price and market discussion above relate to penny stocks already trading in the market. Stocks are introduced into the market through an initial public offering (IPO). In most cases, an IPO would need to be registered with the Securities Division, which applies a set of guidelines to the offering to determine whether the offering is “fair, just and equitable”. Although the “merit” system of applying those guidelines is not foolproof, fraudulent offerings are rejected and not granted registration. For this reason, Missourians are not usually victims of penny stock scams in an IPO,but lose their money in the secondary market. In the secondary market, there are broad exemptions in the law that allow many penny stocks to trade in Missouri without meeting the merit standards.

Legitimate penny stocks

Despite all of the problems with penny stocks and the millions of dollars of loss involved with them,there are legitimate companies whose securities trade in the pink sheets at very low prices. Strug- gling young companies just starting out are perfect examples. Investment in such a company, held through the company’s formative years, can pay off well. Such an astute investment requires three things: the ability to choose the right company, the capital to invest and hold the investment, and luck.
In order to choose the right company, you must know something about the business in which the company engages. You must be able to evaluate the feasibility of the company’s business plan and the company’s ability to compete in its field of en-deavor. You must be able to evaluate the ability of the company’s management to run the company.Finally, you must be able to evaluate the capital-ization and cash flow of the company.
If you find the right company, you must be able to hold the investment for years to allow the com-pany to mature and for the stock to appreciate in value. Investment in “growth” companies is long-term investment. Furthermore, you must have sufficient capital to be able to withstand total loss of your investment. Investment in emerging companies is always a high-risk investment.
Finally, there is simply an element of luck in any stock investment. Luck plays an even greater role in a market in which manipulation is so preva-lent. Some legitimate companies have had their stocks manipulated to such an extent that they were were forced out of business. Even without manip-ulation, the success or failure of a fledgling busi-ness is simply unpredictable.

Sources of information

Your broker can be a tremendous help in evaluat-ing an investment. However, in the penny stockarea, there are many unscrupulous brokers whose only goal is to sell. Be sure that the advice you receive is balanced and addresses your investment needs. When in doubt, avoid a penny stock invest-ment, especially if your broker “specializes” in penny stocks.
The prospectus is the most comprehensive source information about an IPO. It sets out where your investment money will be used, describes the capitalization, history and management of the company and describes the cash flow system of the company. If you need help interpreting the in-formation you find in the prospectus, the Division has another pamphlet in this series entitled “How to Read a Prospectus”.

Trade confirmations contain a wealth of infor-mation. The confirmation will show basic infor-mation, such as number of shares, but will also in-dicate whether the transaction was agency or prin-cipal, was solicited or unsolicited (it will say “un-solicited” if you called your broker to place the order without your broker having tried in any way to get you to place the order) and, in the case of most pink sheet and non-NASDAQ National Mar-ket trades, provide the bid and ask at the time of execution of the transaction.

Manuals such as Moody’s and Standard and Poor’s have current financial information about companies, and most penny stocks are listed in the manuals.
Periodic reports filed with the U.S. Securitiesand Exchange Commission have updated informa-0ption about companies that register with the SEC. The most common report is a “10-K”.

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