Simplifying Penny Stocks: Risks, Rewards, and Strategies for Trading

When it comes to investing or trading in the stock market then there are lots of options available in the market. But we have a common psychology and due to which most of the retail investors run behind cheap stocks. These cheap stocks are called Penny stocks in the language of the stock market. So, today we will discuss the pros and cons of penny stocks and should we invest in them.

Table of Contents :

• What is Penny Stock
• Pros of Penny Stocks
• Cons of Penny Stocks
• Should we invest in Penny Stocks
• Conclusion

What is Penny Stock :

Penny stocks are those low quality stocks which are available at a very low price and have very low market capitalization. In India the stocks which are available at the price of INR 10 and below are basically considered as pennies. These are the micro cap companies whose market capitalization is very low say INR 500 Crore and below. If we see in most penny stocks there is very low growth and sometimes no growth.

Pros of Penny Stocks :

Investing in penny stocks can potentially offer a few advantages, but it’s important to note that they also come with significant risks. Here are some advantages often associated with investing in penny stocks:

1. Low Cost :-

Penny stocks are typically traded at a low price per share, often below $5. In Indian rupees it is considered as INR10. This allows investors with limited capital to purchase a larger number of shares compared to higher-priced stocks. If the stock experiences a significant price increase, the potential gains can be substantial.

With a low price if someone has studied a good stock which has future potential then he can start investing with a small amount also. Small retail investors with high investing skills can make big returns by investing with small investments.

2. Volatility and Potential for High Returns :-

Penny stocks are known for their volatility, which means their prices can fluctuate significantly over a short period. This volatility can present opportunities for investors to make quick profits if they correctly anticipate market movements. However, it’s crucial to recognize that volatility works both ways, and penny stocks can also experience substantial losses.

If a Penny stock has real strength then in a very short span it can provide big returns because it has a big market to capture. This big market will reflect in price and a good micro cap can provide multifold returns to its investors if it has real strength.

3. Growth Potential :-

Some penny stocks represent small companies in their early stages, with the potential for significant growth. Investing in such stocks allows investors to get in on the ground floor of promising businesses that may experience substantial expansion in the future. Identifying these companies requires thorough research and analysis.

But if you have been able to identify that company then these companies grow exponentially. This is why because these have a big target audience and they can focus on that. These are small businesses and can grow faster.

4. Leveraged Opportunities :-

Due to their low prices, penny stocks can offer leveraged opportunities. A small price increase can result in a substantial percentage gain. However, it’s important to exercise caution when using leverage in trading, as it amplifies both gains and losses.

But this is not an advantage completely because stocks always increase in percentage. Yes this can be good for the stocks which trade in cents in the multiple of 5. In that type of stock it gets substantial percentage growth.

Cons of Penny Stocks :

It’s crucial to be aware of the significant risks associated with penny stocks, which include:

1. Lack of Liquidity :-

Penny stocks are often traded on over-the-counter (OTC) markets or small exchanges with limited liquidity. This means that it can be challenging to buy or sell shares at desired prices, and the bid-ask spreads can be wide. Illiquidity can result in difficulties exiting a position or experiencing significant price slippage.

Penny stocks have less buyers and sellers and also they have a lack of shares in float. Also in most of the penny stocks those are held by operators to dump the retailers. So, due to that illiquidity increase and you can’t exit from the stock when you want which can lead to big loss.

2. Limited Financial Information :-

Many penny stocks belong to small or newly established companies that may not be subject to the same reporting requirements as larger publicly traded companies. This lack of information makes it harder to assess the financial health, prospects, and overall quality of the company.

Also there are high chances that the financials shown are fake. High growth is shown to just attract retailers money to trap them. Also big trading apps not go so deep in the financials of these companies due to which complete information doesn’t reach to the retailer. These stocks are not fundamentally sound.

3. Higher Risk of Fraud and Manipulation :-

This is the biggest disadvantage of Penny stocks. Operators buy shares on low and then the stock is promoted through news channels and other media. Due to that retailers make their positions in penny stocks and then operators sell from high stock hits back to back lower circuit and not give chance to get out for retailers.

The penny stock market is known for attracting fraudulent schemes and manipulative activities. Unscrupulous individuals may attempt to artificially inflate the price of a stock to entice unsuspecting investors before unloading their shares, causing prices to plummet.

4. Lack of Track Record :-

Many penny stocks lack a proven track record, making it challenging to evaluate their long-term viability. These companies may have limited operating history or face significant challenges in growing their businesses successfully. This lack of records makes these stocks more dangerous.

5. Trade in Circuit :-

The penny stocks most of the time trade in the upper circuit and lower circuit. In those circuit stocks investor can’t take entry and exit when they want. Due to this money gets stuck and capital keeps drawing down. So, the stock which is hitting circuits, you should stay away from them.

Should you invest in them :

As we have discussed pros and cons of penny stocks, now comes the main question for which you are waiting. Investing decision on any stock is completely your decision. But in penny stocks mostly you should avoid investing. We will strongly recommend staying away from low quality stocks until you have time in the market for more than 5 years. If you are a newcomer then focus on quality stocks.

Don’t get influence with more quantities you will get. Quantity doesn’t matter, Quality matters. You will get recommendations for penny stocks and micro cap companies from different methods but you have to avoid those. Don’t invest by thinking that if One rupee share will become of Two rupees then your money will get double. That One rupee share will not take time to become One paisa share.

So, avoid the psychology of getting more quantities and build the psychology of getting more quality. You can also make your own decision on the basis of

Conclusion :

Investing in penny stocks can be highly speculative and is generally considered a high-risk investment strategy. It’s crucial to conduct thorough research, diversify your portfolio, and exercise caution when investing in these stocks. If you’re new to investing or uncertain about the risks involved, it may be advisable to seek guidance from a financial advisor.

There is no stock recommendation. The information shared above is just for information and awareness purposes. Consult your financial advisor before investing or taking any decision.

Thank You

Happy Investing