What are penny stocks?
Penny stocks are stocks of small publicly traded companies listed on stock exchanges for a price generally lower than Rs. 30. Being low on liquidity, penny stocks could be quite risky to invest in. For instance, you may buy a penny stock at a very low price but may not find buyers when you wish to sell it. Some penny stocks die out with time and may potentially get delisted resulting in losses. Hence, it is not necessary you would be able to make phenomenal returns when investing in penny stocks.
Features of penny stocks
Here are some features of penny stocks:
- Lack of liquidity: Penny stocks frequently suffer from low liquidity, indicating infrequent trading activity with limited numbers of buyers and sellers. This lack of market activity not only complicates the process of selling shares when desired but can also result in substantial and unpredictable price swings.
- Return potential and high risk: Penny stocks present the potential for substantial returns, yet they simultaneously carry a high level of risk. It is imperative to recognise that not all penny stocks will yield positive results, and some may experience a decline in value over time.
- Multibagger opportunities: Certain penny stocks hold the promise of becoming multibaggers, showcasing the potential to multiply in value several times over their initial price. Nevertheless, it is crucial to exercise caution, as this outcome is not guaranteed, and investing in penny stocks demands careful consideration.
- Pricing unpredictability: Penny stocks frequently face sudden and unpredictable price fluctuations, posing a challenge for investors attempting to forecast their market behaviour. This volatility is influenced by various factors, including market dynamics, company-related news, and shifts in investor sentiment.
Additional read: How to Invest in US Stocks from India
Advantages of investing in penny stocks
While penny stocks come with inherent risks, some investors are drawn to them for the potential advantages they offer. Here are a few advantages of investing in penny stocks:
- Low entry cost: One of the primary attractions of penny stocks is their low price. This makes them accessible to investors with limited capital who may not be able to afford higher-priced stocks. The low entry cost allows investors to diversify their portfolios with a relatively small amount of money.
- High return potential: The allure of penny stocks lies in their potential for high returns. Since these stocks are priced low, even a small increase in their value can result in a significant percentage gain. Investors seeking substantial returns may find penny stocks appealing, provided they are willing to accept the associated risks.
- Opportunity for early investment: Penny stocks often belong to small companies with growth potential. Investing in these stocks at an early stage can offer the opportunity to benefit from the company's expansion and success, potentially turning a small investment into a substantial return.
- Volatility: While volatility can be a disadvantage, it also presents opportunities for traders to profit from short-term price movements. Active and experienced traders may find the volatility in penny stocks a chance to capitalise on rapid price changes through strategic buying and selling.
Disadvantages of investing in penny stocks
Despite the potential advantages, penny stocks come with several disadvantages that investors should carefully consider:
- High risk of loss: Penny stocks are inherently risky. Due to their low liquidity and small market capitalisation, they are susceptible to price manipulation, fraud, and sudden declines. Investors may experience substantial losses, and some penny stocks may even become worthless.
- Lack of information: Small companies that issue penny stocks may not be as closely scrutinised or regulated as larger, more established companies. This lack of information can make it challenging for investors to conduct thorough research and assess the true value and potential risks associated with a particular penny stock.
- Limited liquidity: The illiquidity of penny stocks can be a significant drawback. It may be challenging to find buyers when you want to sell, and the bid-ask spread can be wide. This lack of liquidity can lead to difficulties in executing trades at desired prices.
- Vulnerability to pump and dump schemes: Penny stocks are sometimes targeted by unscrupulous individuals or groups engaging in pump and dump schemes. These schemes involve artificially inflating the stock price through false or misleading information, only for the perpetrators to sell their shares at the inflated price, leaving other investors with losses.
Conclusion
In conclusion, while penny stocks offer the potential for high returns, they come with substantial risks that may not be suitable for all investors. It is crucial to conduct thorough research, be cautious of the inherent uncertainties, and consider consulting with financial professionals before delving into the world of penny stock investments.
