Penny Stocks – Definition, Investment Options and Risks

What are Penny Stocks?

Penny stocks attract minimal pricing and have no theoretical definition. It trades at low prices of Rs 10 or even single digits. Penny stocks are generally illiquid and are offered by companies with low market capitalisation. Moreover, as penny stocks are traded less frequently, their prices are highly volatile. 

It is easy to predict the price movements of large-cap stocks through technical analysis. However, it’s challenging to predict penny stock movements because of the lack of price history. Moreover, information on their business and fundamentals are not readily available. 

The penny stock prices rise when there is news about a turnaround in their businesses. It leads to speculation and increased trading volumes pushing up penny stock prices. However, penny stock prices can crash if negative news about their companies goes around. 

Many retail investors invest in penny stocks hoping to earn higher returns quickly. However, penny stock prices can fall very fast and retail investors will lose a lot of money. You can trade with penny stocks on the BSE and the NSE. 

Penny stocks are vulnerable to price manipulations by stock operators. For instance, stock operators can artificially inflate penny stock volumes to push their prices up and trap retail investors. 

After many retail investors invested in the penny stock, the stock operators exit their stock holdings at higher prices. It results in a crash in penny stock prices, and retail investors lose their money. 

What are the features of penny stocks?

• Illiquid

Penny stocks are generally illiquid as companies issuing them are not popular. Moreover, they are categorised by low trading volumes. You may not be able to sell penny stocks quickly if you need money for emergencies.

• Limited historical data

Many penny stocks are those of relatively new companies with little historical information. Moreover, these companies do not have a record of revenues, assets, products or operations, making penny stocks hazardous investments. 

• Low Price

The price of penny stocks in India ranges from single digits to Rs 10.

• Volatile Prices

Penny stock prices are highly volatile as they are vulnerable to manipulation by stock operators.

Should you invest in penny stocks?

Many people invest in penny stocks as they have the potential to become multi-baggers over time. However, it is an extremely risky investment, and first-timers in stocks must avoid investing in penny stocks.

Penny stocks have low liquidity. You may struggle to find a buyer when you sell penny stocks over the stock exchange. Moreover, even purchasing penny stocks is tricky as you may not find a seller at the right time. 

In addition to illiquidity, penny stocks are vulnerable to price manipulation by unscrupulous stock traders, and limited historical data makes it challenging to gauge past price movements. 

Moreover, there are instances where penny stocks have been delisted from stock exchanges and are regularly under SEBI scrutiny. Penny stocks are suitable for market-savvy investors who have higher risk tolerance. 

Things to check before investing in penny stocks

1. Study the company fundamentals such as management quality and financials before investing in penny stocks. 
2. Invest in penny stocks only if you understand their business, products, services etc. Do remember that penny stocks are not lottery tickets. 
3.  Check the company’s promoters holding and share pledge, if any. 
4.  Make sure that the company whose shares you purchase have reasonable liquidity. 
5.  If available, go through the technical factors such as moving averages and RSI of penny stocks. 
6.  As prices of penny stocks are volatile, you must invest only the money you can afford to lose. Moreover, you will not feel the financial crunch even if penny stock prices crash and you lose your money. 
7. Do not rely on information from stockbrokers when investing in penny stocks. You must look for pump and dump schemes signs before committing to the investment. 

Conclusion

You must invest only the money you can afford to lose in penny stocks. Moreover, do not diversify your portfolio with penny stocks but purchase and stay invested in two or three penny stocks. Furthermore, penny stocks are volatile, and you must periodically review your penny stock investments.

FAQs

1. Should you invest in penny stocks to make a lot of money?

You must invest in penny stocks if you are an aggressive market-savvy investor. Moreover, invest only the money you can afford to lose in them. 

2. How long should you stay invested in penny stocks?

You may be tempted to invest in penny stocks for the long term. However, you can follow a strategy where you sell penny stocks if you earn a 15%-20% return in a short period. 

3. Why are penny stocks cheap?

Many people invest in penny stocks because they are available at low prices. However, penny stocks have low market capitalisation, which is determined by two factors, namely the stock price and the number of outstanding shares. As penny stocks are illiquid, you can get them at a low price.