Many investors (especially those just starting out) want to delve into the world of micro-cap stocks, mainly because of the tremendous potential for gain which stocks trading at or below $1 can deliver. Unfortunately many investors get most of their stock training by visiting web sites which specialize in nefarious practices under the guise of "expert opinion". The most important thing to understand about stock investing, and micro-cap investing in particular, is that you should trust no one. Do not trust company officials, investor relations representatives, web site operators, message board bloggers, stock gurus, grandma Miller, uncle John, or cousin Fred. Always find the facts for yourself. Never take anything for granted. Most web sites which profile micro-cap stocks are bought and paid for promoters. And just because they disclose this (which the SEC requires) does not make it better. However, the worst offenders are those not paid in cash but in free trading shares. Some of these operators will be dumping hundreds of thousands of shares (while you are buying). Kind of makes it hard for the price to rise, doesn't it? At bottom, there are several things for an investor in penny stocks to watch out for: high volume, strange financing deals, outrageous claims by the company.
High Volume: This is a primary red-flag for micro-cap stocks. A tiny company that trades more than a $100,000 in (dollar) volume on an average daily basis should be reason for alarm. Most tiny companies with high volume (dollar volume in particular) have a huge amount of shares outstanding and/or are being promoted (usually by dubious individuals).
Wicked Financing: Small companies have a hard time getting big cash injections. One way they get cash is by making complex deals with accredited investors. Some of these deals include warrants, preferred stock, and debentures, set up in ways that could cause a serious amount of dilution. Of course not all deals are bad for the company or for the other shareholders. It really depends on the particulars. Just read through the company filings and you will know when things just don't add up.
A New Breakthrough: When a micro-cap company comes out with a press release which makes a claim (such as a cure for cancer, etc.) be more than a bit skeptical. Outrageous claims are almost always fiction.
The best research is reading the corporate filings. Find them right at the SEC site.