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Investing In Penny Stocks Simplified: Know How Penny Stocks Work
28 June 2022
Contrary to stocks of well-established companies, penny stocks trade at a very low price. This attracts investors who find appeal in small companies. They are willing to take very high risks for substantial profits. So, what are penny stocks, and are they the right investment option for you?
Read along to know how penny stocks work and how to buy them.
What Is a Penny Stock?
Penny stocks are shares that trade at minimal prices on stock exchanges. They belong to small companies with low market capitalisation and tend to be highly illiquid as they are traded infrequently.
In India, these stocks usually trade at prices ranging from Rs. 1 to Rs. 10 per share. They present a great money-making opportunity for investors who are able to identify a multi-bagger stock at its early stage. However, these stocks are high-risk investments with high levels of volatility, chances of fraud and wild price swings.
How Do Penny Stocks Work?
Penny stocks are low-priced shares of small companies. These stocks can show a high and sudden surge in price. They are infrequently traded and have a small number of shareholders. There is also limited information about these companies and no price history.
All of the above factors make penny stocks highly risky and speculative investments. These stocks are also prone to scams, price manipulation, sudden delisting and regulatory hurdles. A market manipulator can easily change the stock price by buying a few thousand shares.
Why Should You Consider Investing in Penny Stocks?
Penny stocks attract investors with the possibility of lucrative returns. The biggest benefit of penny stocksis that investors can potentially turn a small investment into a fortune if they invest in the right stock. For example, if you own 40,000 shares costing Rs. 1, a price increase of Rs. 1 will give you profits of Rs. 40,000.
Penny stocks are a great option for new investors who have just entered the world of investing. Unlike other types of stocks, it is not always possible to predict their price movement using technical indicators. That is why beginner investors, who are unversed in the technicalities of major equity investments, can easily start trading in penny stocks.
Penny stocks also require smaller investments to get started. Investors do not require much capital to grow their wealth using these stocks. Their low prices also limit the losses that investors could potentially incur. Moreover, this allows significant room for potential upsides.
Benefits of Investing in Penny Stocks
The following are some of the reasons why you may consider investing in penny stocks:
Low entry barrier: It is quite easy to start investing in penny stocks. The price movement of these stocks does not follow any set patterns that one can analyse. This makes them a great choice for you to get started on your investment journey.
Generates high returns: Although penny stocks have a reputation for wiping out investors’ gains, not all of them fail to grow. There are many small or newly established companies that have stable financials and scope for growth. With a small investment in such a company, you can make huge profits if you are willing to stay invested for a long time.
Affordable prices: One of the main benefits of penny stocks is their very affordable prices. You do not need to invest a lot of money into these stocks to grow your wealth considerably. Their low costs also minimise losses that you may incur if your investment does not work out.
Valuable investments: Many small businesses issue shares to the public to receive funds. By investing in companies during their early stage of growth, you can get the benefits of significant upsides when they become successful.
How to Buy Penny Stocks?
You will need a penny stock broker to get started with investing in penny stocks. Here are the steps you can follow to get started:
Step 1: Register with a brokerage firm that deals with penny stocks through their online platform.
Step 2: Upload your documents (proof of identity, address, etc.) to the brokerage portal. You also need to deposit an initial amount to start investing.
Before you start trading in penny stocks, you will want to determine if the business is profitable and if it is the right time to buy/sell the stock.
Disadvantages of Investing in Penny Stocks
The following are a few disadvantages of investing in penny stocks:
Poor liquidity: When you buy well-known shares, there is a large market with enough buyers waiting to purchase the shares that you sell. However, penny stocks have very low trading volumes as they are not frequently traded. This makes it challenging to find prospective buyers or sellers.
Unproven companies: Companies issuing penny stocks are small in size and do not have a proven track record. They do not have strict reporting requirements, making it difficult for you to sufficiently research them before investing.
Highly volatile: On account of their low price, penny stocks are subject to high volatility. Just a small move in its price can represent a significant percentage movement. Thus, a small price change can result in significant losses for investors.
Often targeted by scammers: These stocks are not closely observed by the regulatory bodies, making them easy targets for scammers. Con artists can create a spike in their price by buying thousands of shares. Then, they can build hype to drive up the stock prices and dump their shares for profits, causing substantial losses for investors who are late in taking a position.
Here are some of the factors that you will want to check before investing in penny stocks:
You will want to limit your total investment in these stocks to less than 2-3% of your total portfolio to keep your risks manageable.
It is also a good idea to pick penny stocks available on established stock exchanges and avoid those in the OTC (Over-the-Counter) market.
You should consider investing only in companies with reliable information about their offerings and financial statements.
Penny stocks should be a short-term investment option. It is a good idea to avoid holding them for the long term and exit as soon as you get a profit.
Make sure to choose a brokerage firm charging a low transaction fee to avoid reducing your returns.
Penny stocks are high-risk investment options as they do not offer substantial information about their financials. However, the benefit of penny stock investing is that there’s a possibility of getting good returns as the companies grow. If you are an experienced investor, you can consider investing in some penny stocks.
If you are looking for other investment options apart from penny stocks, visit Navi Mutual Fund and start investing today!
*Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
FAQs on What is Penny Stock
Q1. How high are the risks of investing in penny stocks?
Ans:Penny stock investments are mostly speculative and subject to many risks. These factors make it easy for you to lose your money, irrespective of the amount that has been invested.
Q2. What are pump and dump schemes used in some penny stocks?
Ans:Con artists can artificially ‘pump’ up the price of penny stock by promoting it as the next multibagger. After the stock price increases, they can then sell off (dump) their investments, leading to large losses for remaining investors.
Q3. How can you buy high-value stocks with a small amount?
Ans:Many online brokerages allow investors to buy fractional shares. With this, you can buy a portion of a single expensive stock while paying a fraction of its cost.
Q4. Why is it hard to predict the price movements of penny stocks?
Ans:The lack of price history, price quotes and narrow bid-ask prices of penny stocks make it difficult for investors to predict their price movements. Moreover, these stocks are vulnerable to significant price fluctuations and scams.
Q5. How can you find stocks that can provide multi-bagger returns?
Ans:To pick a penny stock that can offer multibagger returns, you need to have a complete understanding of a company and its future plans. You also need to have the talent to discover hidden gems that are currently highly undervalued.
Before you go…
Want to put your savings into action and kick-start your investment journey 💸 But don’t have time to do research? Invest now with Navi Nifty 50 Index Fund, sit back, and earn from the top 50 companies.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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