The Latest News From The Motley Fool: Penny dreadfuls

FOR THE first time, a Fool has testified before the US government. At the beginning of last week, Tom Gardner, one of the co-founders of the Motley Fool, testified before a US Senate committee on penny stock investing and daytrading, among other things.

Neither of these are new phenomena, but the rise and rise in personal stock ownership that has been brought about by the explosion in internet use has lent them a greater prominence. And whatever is topical in the American stock market will very shortly be topical here too.

For many of us in Britain, the internet is already changing the way we look after our own investments. Company information available over the web is improving all the time and with three real-time share dealing services already online (Barclays, Charles Schwab and Stocktrade), the gap between the professional and the amateur is shrinking rapidly.

We can expect to see a major shift in patterns of personal investment in the next several years, with the balance of power swinging towards the individual with a humble home computer (whose price, of course, is shrinking all the time).

The first thing Tom talked to the US senators about was penny stocks. At the Motley Fool UK, we actively discourage discussion of shares with a market capitalisation of less than pounds 30m or a share price less than 50p. The financial and background information available on such companies is often limited and they have little liquidity and a limited float (few shares available for public trading), which means the price can be artificially inflated, for a short while anyway. This volatility recreates the thrill of a casino, with about as much chance for the investor to turn a long- term profit.

Fearful doomsayers flock to any revolutionary innovation, and so it is with the internet, in particular in relation to penny shares. The fear is that the internet will be used to "ramp" or hype such shares. In our experience, this is actually less of a worry online than off.

The internet makes it harder for malefactors to get away unseen. Unlike telephone or personal contacts, internet scams leave themselves open for rebuttal by others in online communities, such as that of the Motley Fool.

It can be hard to ramp a share in a chat room, for example, when hundreds of others can easily challenge the promotion, demanding evidence and the source of that evidence in their search for a hidden agenda. If every investor had access to this public dialogue, made possible only by the internet, then the misdeeds of hypesters, crooked brokers, financial advisers intent only on maximising their own commission and other ne'er-do-wells would be fodder for the mockery of the people.

Perhaps most importantly, though, internet messages leave "footprints". They can provide all the clues to a crime; clues that Arthur Daleys can never be sure the authorities won't find.

And then there's daytrading. This is the phenomenon where investors hold shares for only hours or even minutes at a time, aiming to profit off short-term price fluctuations. In the US, daytrading "parlors" have been set up and some people have even left their jobs to daytrade.

It is not a new phenomenon, but for the vast majority of people it has always been and will remain deeply unprofitable. The incentive to manipulate share prices by spreading rumours and half-truths is undoubtedly strong for the daytrader and this is just one reason why we actively discourage it at the Fool.

There is no doubt, however, that as online share dealing takes off in Britain and charges decline, some people will be tempted into it. That's a shame, but our response is to offer education to combat ignorance, not to condemn the internet out of hand.

Is there danger for the unwary investor on the internet? Yes, definitely. Is there danger for the unwary investor in the offline world? Yes, definitely. Does the internet represent an unprecedented opportunity for individuals to take control of their own financial destiny ? Yes, definitely.

If you're worried about using the internet to help you invest, ask yourself if the term "unwary investor" applies to you. If it doesn't, you have no worries. If it does, you have a little Foolish work to do before you start managing your own money.

www.fool.co.uk

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