Do You Know What Penny Stocks Are?

Penny Stocks
by Nikita Bhoota 07/09/2021

Penny Stocks are stocks that trade at a low price and have a low market capitalisation. Penny stocks are also popularly known as nano-cap stocks, micro-cap stocks, and small-cap stocks, depending on the company’s market capitalisation. Market capitalisation is calculated by multiplying market price of a share by outstanding shares of a company.

Investing in penny stock can give huge returns in a small amount of time but at the same time, the investor may lose the entire capital in an equally short period because of its high risk high return characteristic. Therefore, it is important to choose penny stocks with great caution and after studying the fundamental aspects of the issuing company.

Features:

Low Pricing: Penny stocks generally trade below Rs10 in India. So the investor can purchase a substantial quantity of stock units with a small amount of investment.

Low Volume less liquidity: Several Penny stocks generally trade at low volume means if an investor wants to sell and come out of the investment, there might not be any buyers. This means the stocks are generally illiquid.

Wide bid-ask spread: The bid-ask spread is very high in penny stocks that make it very difficult to sell one’s shares at the desired price.

High Risk High Return: These stocks provide much higher returns compared to other forms of securities. As such shares are issued by small and micro-cap companies, they have huge growth potential. Consequently, penny stocks are risky, given its intensity of response to market fluctuations.

Unpredictable Pricing: Penny stocks sometimes might not attract adequate pricing during the sale. It might result in a low profit or a loss-making investment. Similarly, these stocks could also attract a price significantly higher than the buying price; therefore, resulting in a magnificent profit.

Risk associated with Investing in Penny Stocks

Lack of information: The market information of these companies is not easily available as compared to big companies. Information related to management, financials, history and future plans needs to be known before deciding whether to invest in the company or not. The lack of such information makes it more difficult to select penny stocks for investing. Therefore, they are considered to be riskier than other forms of investment.

Higher Chances of Scams: As the penny stocks generally trade at a very low price and volumes. It usually becomes easy to bring about changes in their prices very quickly and relatively with a small amount of capital. Historically, there have been pump and dump scams where some people have manipulated to increase the prices of stocks. When the bubble burst, many investors have got their hands burnt. The only ones to make profit out of them are those who buy stocks at a very low price and decides to exit at high peak prices.

Also Read: Should you Invest in Penny Stocks?

Mistakes to avoid while investing in penny stocks

Keep all your eggs in the same basket: As the risk associated with these kinds of stocks is huge, it is always advisable to diversify one’s investments among carefully researched stocks. This is important to protect the invested capital.

Not selling at correct time: Timing plays an important role while investing in penny stocks. Once the stock is showing good returns, the investor should book profit at that time rather than waiting for a longer time and end up losing the already made profits.

Lack of Research: One should do complete research about the companies issuing penny stocks with respect to companies’ financials, companies’ history, liquidity and volumes of stocks trading in the stock market.

Is it worth investing in penny stocks?

Penny stocks seem to be attractive as the stocks are available at very low prices. The stocks can generate fantastic returns but at the same time, the investment involves high risk.  A penny stock can make you rich but it can also result in heavy losses. So, before investing money in penny stocks, the person should research the company and understand its fundamentals. 

Rules to follow While Investing in Penny Stocks:

Here, are some of the rules to follow while investing in penny stocks

1.    Avoid investing a huge amount in penny stocks. It is recommended not to invest more than 10% of the total equity portfolio in penny stocks.

2.   The principle of diversification will not work here. Instead of picking up many penny stocks, invest only in 2-3 scripts. Spreading your money across a basket of low-priced stocks will not let earn a meaningful return.

3.    Investing in these stocks should be treated as a short-term strategy, not a long-term strategy. If the stock sees a sharp rise, consider it as a time to exit or at least book partial profits.

4.    Suppose, if invested in a penny stock at Rs 4 and it is now trading at Rs 2, don’t try to average out the purchase by buying more of it. It is likely that you may end up digging a bigger hole for yourself and lose more money.

Disclaimer: The above report is compiled from information available on public platforms. These are not buy or sell recommendations.

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