Successful companies aren't born, they're made. Companies usually have to work their way from humble beginnings through the ranks just like everyone else. Unfortunately, some investors believe that finding the next big thing means scouring through penny stocks in the hope of getting a piece of the next Amazon (AMZN) or Meta (META), formerly Facebook. In most cases, this strategy will prove to be unsuccessful. Here's why pinning your hopes on penny stocks could leave you penniless.
What are Penny Stocks?
- You may have heard the term penny stocks, but you're not sure what they are. They aren't the same as stocks that are "penny" stock trading.
- What are penny stocks? Are they good to invest in? The terms "stock", "stock trading", and "stock market" are often used interchangeably. This is because all of them refer to individual stocks or stocks in general. Penny stocks can be considered viable investments in certain circumstances.
Table Of Content
- What are Penny Stock?
- How to Identify Penny Stock?
- How trade Penny Stock?
- How to Choose A Winning Or A mulitBagger Penny Stock?
- Pros And Cons of Penny Stock
- Penny Stock Scams
Understanding The Penny Stock
- In western markets, shares that trade below $1 are usually called penny stocks. But this basket also includes stocks priced under $5. Penny stocks are highly risky, but some of them also have the potential of turning a small investment into a fortune. For example, if you own 50,000 shares of a penny stock priced at $1, even a $1 rise in the share price can give you $50,000 in a single day. This is not possible in the case of a large stock, because it would require large capital to buy such a large volume of shares. There are a lot of downsides to penny stocks too, as they are prone to price manipulations, sudden delisting and regulatory scrutiny.
- One can move the stock by buying thousands of shares and create a spike without leaving any cue for the average investor to know whether the spike in price is genuine or manipulated. Also, penny stocks are more prone to scams, as they are often not regulated by a national-level stock exchange. Because of all these risks, stock exchanges put these types of stocks in a different category, called as trade-to-trade basket. In this category, no intraday share trading is allowed. Transactions have to be compulsorily settled on gross basis, which means you must deliver the shares on the same day if you have sold them or take delivery if you have bought them.
How to Trade Penny Stocks?
You will need a penny stockbroker who will get you started on trading penny shares in India so that you get the hang of the process of selling them.
To start with, you need to register with a broker through an online brokerage platform. This can be done from anywhere around the world via phone or email. Once registered, you will need to deliver some documents like:
The first step is to determine whether the business has to be sold or not. If the company has turned into a profitable business, it can be sold at a reasonable price. The second step is to know the right time to sell the stock.
Penny stock trading is not suited for everyone. If you trade penny stocks, you should know....
- 1) Penny Stocks Have High Price Volatility: Penny stocks generally have higher price volatility than blue-chip stocks. This means that the prices of penny stocks may fluctuate substantially over a relatively shorter period than other securities such as blue-chip stocks. Price volatility is a risk factor that may cause significant losses if the investor wishes to trade (buy or sell) such securities over a shorter period or without proper research.
- 2) Lack of Liquidity: Penny Stock trading in India is dominated by retail investors through small savings schemes. Therefore there is a limited number of buyers and sellers at any given point in time. Lack of adequate liquidity reduces the ability to buy/sell securities quickly at reasonable prices, which may make it difficult for an investor to achieve fair market value for his shares held in his Demat account or desired exit price
How to identify Penny Stock?
While there are several ways and tactics for trading penny stocks, the best advice is to conduct your due research on each one. It's vital to learn how to read and interpret technical charts and patterns before investing in penny stocks. Stick to simple analytical techniques like support and resistance levels if you're new to chart trading. Examining a 3-month price chart using daily data is a straightforward procedure.
Studying how patterns play out in the penny stock segment is the greatest method. The results and patterns keep repeating themselves. As a result, a thorough and consistent investigation will enable you to profit from the predictability. Penny stocks have the following characteristics: Low cost and low volume of trade, Unpredictable results, Smaller business, It is speculative, Market capitalization is low, Factor of high risk, erratic Price fluctuations.
Important Factors to Consider when picking the right Penny Stocks
- 1. Price Behavior
So, price behaviour is one of the ways to judge whether the price is becoming strong or not. But for identifying a good penny stock, price behaviour is not enough. One should look at other factors as discussed below.
- 2. Changes in Business
One should also note what the changes in the business are? Is the company doing an expansion? Or has the management changed? Or whether revenues are growing?
So, the impact of all these things can be seen on performance. So, if we find out companies around the performance of its business that is a penny and any type of recovery can be seen.
- 3. Fundamentals of the Company
Also, checking the fundamentals of the company is essential. Below are some of the essential fundamentals that one should check before investing in any company:
- 1.Market Capitalization: First of all, one should check the company’s market capitalization to know whether the stock falls under the small market capitalization criteria.
- 2. Shareholding Pattern: Also, we should check whether the promoter of the company is increasing or not and who is the non-institutional investing in the company.
- 3. Cash from Operation: We should also check cash from operations from which the company is generating its business, so in the previous quarter, the company generated cash from operations in this case:
- 4. Management of the Company: Checking the company’s management is one of the most significant criteria for investing in penny stocks. Therefore, one should doubt that company that does not have details of its management on its website. Typically, good management has a LinkedIn profile on the page. If there is no LinkedIn here, then we can doubt that company.
Pros and Cons of Penny Stocks
- The Pros of Investing in Penny Stocks
- Low cost
Penny stocks trade for a very low price. Suppose the lot size of a penny stock is not so big that an investor needs to put forward a similar amount of capital as they would with blue-chip stocks for a meaningful quantity. In that case, newcomers to investing will find penny stocks approachable as compared to investing in blue-chip stocks, which have larger per-share prices and huge volumes. So, you may invest in penny stocks without needing huge capital and yet attain a bigger volume.
- High Returns
New and small companies who haven’t made it big yet, may often start as penny stocks. Investing in such companies before they make it big and thereby reaping the returns makes penny stocks attractive. Good penny stock in Indian markets may allow an investor to make humongous profits.
- Chances of overnight gains
Penny stocks are issued by small companies that haven’t yet reached their potential. Suppose a case where a penny stock company suddenly enters the headlines for the right reasons (for example, good credit ratings, sound fundamentals, good management, good market positioning, etc.). In that case, they might experience overnight gains in stock prices.
- The Cons of Investing in Penny Stocks
- Unpredictable pricing
Predicting the price of a penny stock is very difficult due to limited information, infrequent trading and the scope of fraudulent activities. The price ceilings and floors are more flimsy in penny stocks than blue-chip stocks. An investor may make a lot of money overnight. On the flip side, they may also lose it in even less time. Even the top penny stocks with high market capitalization may experience extreme volatility.
- Limited information
It is challenging to learn about a penny stock company’s financial soundness, management quality and overall performance. As compared to blue-chip companies, an investor will have a lot less research on their hand while making trading decisions in penny stocks. Often there is hardly any information about their historical performance as a business.
- Low liquidity
Even if you have never invested in your life, you can name at least one large-cap company just by looking around your room for some branded products that you may own. On the other hand, penny stocks do not enjoy this popularity. This is reflected in their low trading volumes. Low trading volumes make it difficult for investors to buy or sell penny stocks. An investor may feel locked in penny stocks as there might not always be a person willing to take the other side of the trade.
- Prone to scams
Due to the low trading volumes and stock prices, penny stocks are attractive to scammers aiming to manipulate the price to make profits at the expense of unsuspecting investors. Investors may lose significant amounts of money due to some parties or groups manipulating the price.
Penny Stock Scams
Penny stocks have been a thorn in the side of the SEC for some time. That's because the lack of available information and poor liquidity make micro-cap stocks an easy target for fraudsters. There are many scams used to separate investors from their money. The most common include......
Biased recommendations. Some micro-cap companies pay individuals to recommend the company stock in different media such as newsletters, financial news outlets, and social media. You may receive spam emails trying to persuade you to purchase a particular stock. All emails, postings, and recommendations should be taken with a grain of salt. If you notice that people or companies are being paid for their services, it generally means it's a bad investment. Also, make sure any press releases aren't given falsely by people looking to influence the price of a stock.
Offshore brokers. Under Regulation S, the SEC permits companies selling stock outside the U.S. to foreign investors to be exempt from registering stock.5 These companies typically sell the stock at a discount to offshore brokers who, in turn, sell them back to U.S. investors for a substantial profit. By cold-calling a list of potential investors investors with enough money to buy a particular stock and providing attractive information, these dishonest brokers will use high-pressure boiler room sales tactics to persuade investors to purchase stock.