Penny stocks are those stocks that trade at very low prices and belong to the companies that have very low market capitalization. The price range between which most of the penny stocks trade is ₹0.05 to few hundred rupees.
The market capitalization of the companies (for such kinds of stocks) ranges between ₹100 – ₹200 crores.
Now, let us discuss various aspects related to investing and trading in penny stocks, its advantages and risks associated with the investments.
It is true in almost all the cases that the higher the risk, the higher the return.
Investing in penny stocks has the potential to give huge returns in a very small amount of time but at the same time, they have the potential to wipe out the entire capital in an equally small amount of time.
Therefore, it is extremely important to choose penny stocks with great caution and after researching thoroughly about as many aspects of the companies issuing them as possible.
Some of the tips to choose the best penny stocks have been listed below:
Detailed Research – The first and foremost tip is to research the companies issuing penny stocks. The history of the company is one of the things to look for.
One should try to gather as much information about the companies as possible and try to look for any red flags. Information about financial statements, management, etc. should be looked into.
If there is very less information available on the internet about a company, that should be a concern and one should try to avoid trading or investing in such stocks as the chances of fraudulent practices increase in such cases.
Check the Volumes Traded and Liquidity – After narrowing down one’s choices of penny stocks after careful research, one should check the traded volumes of the stocks.
There is no use in investing in a stock where there is very less liquidity as it is going to difficult to offload those shares when they start showing profits.
It is important to check the average monthly trading numbers.
Penny Stocks Advantages
Here are some of the quick advantages of investing in Penny stocks:
Low Capital Required – Since the prices at which penny stocks trade are quite low, it is easier to buy shares with a very small amount of capital. In order to get a hang of investing, one can start investing in penny stocks.
Probability of Higher Returns for Traders – If a trader has chosen the penny stocks carefully to invest in, it is quite probable that his / her investment will grow at a very fast pace as the price fluctuations in penny stocks are quite large. They move up very quickly.
Long Term Investments Could Increase the Capital Many Folds – Sometimes, penny stocks increase and become mid-cap stocks in a few years.
In these cases, if an investor had bought the stocks at the right time, his / her investment could grow multiple folds. The chances of this happening in large-cap stocks are comparatively lower.
Let us see some examples of penny stocks that became multi-baggers and grew by more than a thousand times over a period of years
Eicher Motors – In the year 1998, the stock of this huge company was trading at around ₹9. In the year 2018, it was trading around ₹23,124. It has increased by about 2,555 times.
Kotak Mahindra Bank – Its price used to be under ₹10 until most of the year 2013. It currently trades at a price of around ₹1507. It has shown a growth of around 150 times.
Penny Stocks Disadvantages
Every coin has two sides.
Some of the disadvantages of putting one’s hard-earned money in penny stocks have been discussed below:
Greater Risk – Investing in penny stocks is considered to be riskier as compared to investing in shares of companies of higher market capitalization. The prices of penny stocks can go down as quickly as they can move up.
If the stocks have not been carefully picked, all the investment in penny stock could be wiped away in a very short interval of time. They are the riskiest investments among small, mid and large-cap companies.
Liquidity Problems – One of the major problems with penny stocks is that they are generally illiquid in nature which means that even if one wants to sell them, it might become difficult to do so due to the absence of interested buyers.
Low Volume Trading and Wide Bid-Ask Spreads – Since the volumes of shares of penny stocks are quite low, it can cause liquidity problems.
The bid-ask spread is quite high in penny stocks which may make it very difficult to sell one’s shares at the desired prices.
Limited Disclosure of Information – The vital information about the companies issuing penny stocks is quite less as compared to big companies.
Information related to financials, management, history and future plans needs to be known before deciding whether to invest in a stock or not. The lack of such information makes it more difficult to choose the penny stocks for investing.
Therefore they are considered to be a lot riskier than other forms of investments.
Higher chances of scams – Since the penny stocks are traded at very low volumes and prices, it is comparatively easy to bring about changes in their prices very quickly and with relatively less amount of capital.
There have been many pump and dump scams where some people have manipulated to increase the prices of stocks. When the bubble burst, a lot of investors had got their hands burnt.
The only ones to make a profit out of them were those who had bought those stocks at very low prices and exited their positions at the high peak prices.
Mistakes to Avoid While Trading in Penny Stocks
Here is a quick look at some of the common mistakes done by novice traders:
Lack Of Research – One must be thorough in his / her research about the companies issuing penny stocks with respect to the company’s history, financials, liquidity and volumes of stocks trading on the stock exchanges.
Keeping All Your Eggs In The Same Basket – Since the risks associated with these kinds of stocks is huge, it is always wise to diversify one’s investments among carefully researched stocks. This is imperative to preserve one’s capital.
Not Keeping Strict Stop Losses – Many people make the mistake of buying more penny stocks when their prices drop in order to average their total cost.
It is advisable to decide stop losses before entering into any trade and then, strictly adhering to them.
Lack of discipline can prove disastrous in penny stocks.
Not Selling At the Correct Time – Timing is very important in penny stocks. Once a stock is showing good returns, one should take the profits then and there only, rather than waiting for a long period of time and end up losing the already made profits.
Penny Stocks to Buy
Let us examine some of the well-known penny stocks that are trading in Indian stock market.
Calcom Vision – It is a consumer durables company listed on the Bombay Stock Exchange with a market capitalization of ₹36 crores. The current market price (at the time of writing this article) of this penny stock of this company is ₹19.10.
The average monthly traded volume of Calcom is 9.31 thousand.
Viceroy Hotels – It is the owner and operator of some hotels and restaurants. The stocks of this company are listed on both the National Stock Exchange and Bombay Stock Exchange. Its market capitalization is ₹5 crores.
The current market price of its stocks is ₹1.33. Its average traded volume for the month of June 2019 was 48.5 thousand.
The one month return of this stock has been -18.75% and return in investment over the last one year is -81.43%.
Archies – It is engaged in the manufacturing of paper and paper products and sells cards, gifts and stationery. The stocks of this company are listed on both the National Stock Exchange and Bombay Stock Exchange.
The market cap of this company is ₹56 crores. The stock is trading around ₹16.2. The average traded volume of this stock for the month of June 2019 was 163 thousand.
The one month return of this stock has been -19.22% and the one year figure stands to be -44.3%. The PE of this stock is 79.05.
Leel Electricals – It is a home electronics and appliances company which is listed on the BSE. Its current market cap is ₹19 crores. The current market price of the stocks is ₹4.74. The average traded volume of this stock for the month of June 2019 was 155 thousand.
The one month return of this stock has been -48.7 % and the return in investment over the last one year is -95.08%. Its PE is 0.04.
Here is a quick summary on Penny Stocks with information on areas that you must be aware of for understanding Penny Stocks:
1. Penny stocks are stocks trading below ₹10 of very small-cap companies. Penny stocks are a high risk and high return kind of strategy.
2. The main advantages of investing in penny stocks are the probability of growth of capital multiple times and less requirement of capital to start investing in the stock market.
Some penny stock companies have been multi-baggers in the last few years.
But at the same time, investing in penny stocks is considered to be highly risky and if not managed properly, has the potential to wipe out the entire capital.
3. If a trader decides to invest some part of their capital in penny stocks, then, full research about the company’s history, financials, management, etc. is a must.
Another extremely important thing is to check the liquidity and trading volumes of the penny stocks.
One should try to avoid trading in stocks that are traded in low volumes as this would cause liquidity issues resulting in failure to offload stocks when the time arises.
4. The common mistakes that a trader makes while investing in penny stocks are not doing thorough research, and not selling the stocks when a decent profit has been made in anticipation of more growth in stock price.
Another major mistake is not maintaining discipline while taking exits from the stocks.
Some traders try to bring down the overall cost of their stocks by buying additional stocks at lower prices. A better option is to stick to a strict pre-decided stop loss and take a small loss in order to shield oneself from huge losses.
In case you are looking to get started with investments, let us assist you in taking the next steps ahead.