When starting to invest in stock markets for the first time, Most of the investors chose penny stocks for investing. Penny stocks are the most famous and chosen stocks by the new retail investors. Most of the trade volume in these stocks are due to these new and retail investors only. We will understand what are penny stocks and what is the risk that is involved in investing in these stocks and what is the risk to reward ratio.
The penny stocks are most attractive to new investors because of their cheap prices. Most of the penny stocks are prices in single digits and they become attractive as the investors are getting a large volume of share for fewer prices.
In this article, we will discuss the advantages and disadvantages of investing in these cheap prices stocks. But when you suggest an experienced investor for suggestion on whether to trade in these stocks or not, the most probable answer will be to avoid such stocks because they are a trap and the risk involved will be very high in such stocks.
What are Penny Stocks
Penny stocks are those stocks which are priced very cheap mostly under ₹10 and the market capitalization of these companies is very less. These stocks are mostly traded by very few people and very rarely these stocks see high volumes. Hence the liquidity of these stocks is very less and some times it is difficult to exit from these stocks as there won’t be buyers at a certain point of time.
You can find the stocks of these companies listed both on the National stock exchanges(NSE) and Bombay stock exchanges(BSE). They belong not to small-cap but less than small-cap based on the market capitalization.
Based on this factor, companies are indexed in recognised stock exchanges such as the National Stock Exchange and Bombay Stock Exchange. Penny stocks lists are often found in the lower sections of such stock exchanges or lesser-known stock exchanges.
What are the features
High Returns: Usually the stocks with cheap prices are of the companies which are in early stages of their development and have huge potential to grow, and we expect multiple time returns form these stocks. The stock prices of these companies will rise multiple time when the company is growing. Being an early investor can gain huge returns from these stocks.
Low Liquidity: The liquidity in these stocks in India is very less when compared to others. Penny stocks can be categorized as an Illiquid stock because of their low liquidity in the market. Most of the times it becomes difficult to find a buyer for the stocks when we wanted to exit and we need to place a market order to get a buyer for our stocks.
Un Predictable: The prices and the movement of the prices of penny stocks are unpredictable. the stock prices some times move in a different direction to the overall sector movement. this unpredictable price movement makes it risky and also sometimes rewarding for the investors.
Why should you invest in these stocks
Penny stocks are like hit or miss type stocks. When you decided to invest in these stocks then you must realize that you can multiply your money multiple times with huge returns if the company grows and at the same time you can incur hugely loses as these companies are huge risk companies and the stock pricing is unpredictable in such stocks. Hence you have to invest that amount of money which you can risk to lose a major portion of it or sometimes completely.
Multi Baggers: As we have been speaking as these companies have huge potential to grow in the future, your investment may give huge returns. When the company proves itself and it grows your investment multiplies multiple times. Hence these stocks turn out to be multi-baggers if selected properly.
Less Expensive: these Penny stocks are least expensive. You can buy hundreds of quantity with the least investment because of their cheap pricing. Hence when the company grows you can hold a huge quantity of shares and get good returns.
When experienced Investor suggests all the new investors to stay away from penny stocks, they must be suggesting with a reason and from their experience. Yes, penny stocks involve huge risk with the rewards they may give. The following are the risk involved in investing in Penny stocks.
Less Information: When compared to other large-cap and mid-cap companies, We have limited information about the companies with penny stocks. These companies most of the times fail to comply with the stock exchanges or regulatory norms and the information provided by these companies to the public may not be to the point. And also we have less information about the operations of the company, the business model and about the future plan of the company.
Scams: penny stocks are avoided by the most because these are a major source of stock market scams. If you are not careful you can be a victim of these scams and before you realize you might have lost all your money. The popular method used by many is “Pump and Dump”. Companies and scammers purchase a considerable amount of penny stocks resulting in value inflation which attracts other investors to follow the hype. However, once enough buyers have invested in such stocks, such companies and scammers dump their shares. This results in an immediate lowering of value followed by losses on the scrupulous investors’ end as they try to sell it.
Bottom line – Penny Stocks
Penny stocks are a good instrument to trade with the possibility of large returns on the investment. But if you observe all the successful stocks which have given huge returns to the investors, you will find that there are only a bunch of such companies and most of the companies turn out to be not worthy of investment. Hence it is difficult to identify those such penny stocks which have the huge potential to grow and give good returns to the investors. Fundamental analysis is the key tool here with proper carefulness about the authenticity of the information you are refereeing to will give you success.