The Five Biggest Penny Stock Scams to Watch Out For

When it comes to penny stock investing, the scams get mentioned more often than the big winners.

That's with good reason. There are a number of penny stock scams designed to separate investors from their hard-earned money.

What penny stock investors really want to find are those little-known companies set to soar – and they are out there. When companies hit it big, either with a new product or following regulatory approval, their stocks can take off.

However, penny stock scammers understand that all too well, and devise schemes to capitalize on investors who don't do the right research to separate the legitimate companies from the traps.

To make sure you don't get suckered by professional scam artists, we put together the five very common penny stock scams to look out for as you hunt for the next big winner (which we'll also help you find).

The Five Biggest Penny Stock Scams on the Market

Pump-and-Dump: The "pump-and-dump" is arguably the most famous and prolific penny stock scam investors encounter. Essentially, promoters hype up investor sentiment in a little-known or unknown stock. New investors rush in, thus "pumping" up its price. Once shares are inflated, insiders then "dump" their shares at a huge profit and leave investors holding the bag.

The promoters behind pump-and-dump schemes use a variety of tactics to spread the word about these penny stock companies, including: fake press releases, aggressive phone sales, or email campaigns. Whatever the tactic, promoters will inevitably offer investors an inside tip on a stock that is about to take off. For those who unfortunately buy into the scam, they can see prices skyrocket, only to crash soon after.

This is why it's important for investors to research the company behind the stock – has it made money? What products does it make/sell? What's the outlook for the sector? Know who you buy.

Short-and-Distort: The "short-and-distort" scam works like a reverse pump-and-dump. Schemers short-sell a stock and then spread false and damaging rumors about the company. At that point shares tank and the original investors hold a losing stock. The short-sellers, of course, have made money on their short positions in the company. One of the most frequent allegations used by short-and-distorters is that the company in question is facing a massive class-action lawsuit.

While this scam isn't exclusive to penny stocks, damaging news can have a much harsher impact on a small-cap companies than on a medium-caps or large-caps. As always, investors should look at the strength of a company before buying into a stock. If a company's business isn't established/successful enough to weather false allegations, it's best to avoid the stock completely.

Money Morning Members – keep reading for three more penny stock scams to watch out for.