How does Penny Stocks work ??
What Are Penny Stocks?
Stocks which trade at a very low price and have a low market capitalization is called a Penny Stock.
Normally, A penny stock in India trade at around Rs 0.05 to Rs 10 Per share.
These companies are ultra micro-cap companies with a market capitalization of less than Rs. 50 crore.
What are the advantages of investing in penny stocks
- Penny stocks are generally not known to the investing public at large. Regular investors do not invest in such stocks because of a fear that the fundamentals are not known. Institutional investors also stay away from such stocks because of the low market capitalization.
- However, this is where the advantage arises to an investor who is prepared to do proper homework into the fundamentals of the penny stock.
- If the investor is able to find a penny stock with good fundamentals and is able to buy the stock at extremely low valuations, he can make an enormous fortune.
Risks and Disadvantages
- The first risk of investing in penny stocks is that their fundamentals are not very well. The investor has no access to proper research reports. Even the credibility of audited accounts can be called into question.
- The second risk is that they have an extremely low volume of shares traded. This means they an easy target for unscrupulous operators to manipulate the price of the stock by cornering a large quantity of the stock and sending the price to soar or dumping a large quantity and sending the price plunging.
Risk of Stock Exchange restrictions
Due to the fact that these are ultra small companies. Their compliance with rules and regulation may be casual. They may attract an adverse regulatory action from the stock exchanges. which can lead to suspension of the scrip from trading.
The other risk factors are that the Stock Exchanges (BSE & NSE) imposing upper and lower circuits on the companies to prevent excessive speculation.
Penny Stock to Multibagger
If the investors are smart and able to find the proper stock, then these stocks can be future multibaggers and investors can make gigantic amount of wealth.
Some penny stocks like Gayathri Sugars, NetVista Ventures Ltd, KM Sugar Mills Ltd, Sybly Industries Ltd etc all have given more than 300 stocks.
There are up to 33 penny stocks have given a return ranging from 100% to 300%
Rules For Investing In Penny Stocks
Investors desiring to invest in such stocks must do so with the following rules in mind. These rules will ensure that even in the worst-case scenario, the investor will not be badly affected:
Investors bold and ready enough to invest in such stocks must consider the following rules in their mind. These rules will ensure that in the worst case the investor doesn’t sustain much damage.
- Invest only petty amounts: Ensure that only a small amount of the portfolio is invested in such stocks, not exceeding 10% of the portfolio.
- Diversify widely and have a basket of a penny stock: It is always sensible to treat penny stocks as a basket and spread the investment and risk across four or five stocks. However, the downside of this strategy is that even if one or two stocks become big winners, the impact on the portfolio will be reduced because of the other stocks in the portfolio.
- Monitor the performance regularly: Penny stocks are not bought and forget stocks. By their very nature, they require to be watched carefully. At the slightest sign of trouble with regard to the fundamentals, the investor must be prepared to sell his stocks.
- Be suspicious of research reports which paint an all positive outlook: Penny stocks are the favourite hunting ground of operators and manipulators. They try to lure in naïve investors by projecting an unrealistic and rosy picture of the stock. Then, when the naïve investors have bought the stock, the operators dump the stock leaving the investor high and dry.
- Keep a strict loss: Unlike stocks with good fundamentals where weakness or dip in stock prices provides Investors with an opportunity to average the stock price, penny stocks should be subject to a strict stop loss. A dip in the stock price is usually a sign that the fundamentals of the stock are deteriorating. Trying to average such stocks can lead to further losses for the investor.