Penny stocks are a category of stocks offered by companies who have very low stock share prices.
Investing in these types of stocks is very popular in the stock market, and it can provide you with a number of advantages as an investor.
At the same time, there are a few disadvantages that you should be aware of. Here are some of the pros and cons of penny stocks.
As the name indicates, penny stocks are the stocks worth less than Rs10 in the Indian stock market.
Penny stocks are highly volatile in nature and have a small market capitalization.
These stocks are considered to be highly risky due to certain factors like liquidity, a smaller number of shareholders, large bid-ask spreads and limited disclosure of information.
These are nano-leveled stocks usually belonging to new companies, bankrupt organizations or sometimes, the fake companies.
Yes!! This is the hard truth associated with penny stocks.
You should not panic as there are many good and prospective companies having a probability to grow and those begin their share distribution with penny stocks.
Penny stocks come in several forms.
They include those, like Audible, that the Nasdaq tossed off its primary exchange when they fell short in a set of financial tests, though they could be traded on Nasdaq’s bulletin board because they remained current in their S.E.C. filings.
Then there are the ones kicked off the Nasdaq or the New York Stock Exchange whose filings are not current.
Those are traded on the over-the-counter market known as the pink sheets.
Trading in stocks itself comes with a certain amount of risk and it is more so in the case of penny stocks.
While investing in penny stocks can give you profit, it can also result in a substantial amount of loss in some cases.
Why do people buy a stock even when they know there’s a good chance its price is manipulated?
Because they want to get rich, whatever the risks.
That’s one takeaway of new research by a group of economists studying penny stocks that were heavily touted through suspect email campaigns.
It may also explain why people pile into other kinds of risky assets—like initial coin offerings—despite warnings from financial experts.
There is so much volatility and hence so much fun trading the penny stocks listed in the BSE.
Penny stocks are basically trading below Re. 1.
There are nearly 130 Penny stocks trading in the BSE 2016 has not been a good year so far.
Penny Stocks are not traded on major stock exchanges, but Over-the-Counter (OTC) bulletin board.
There is a broker involved in trading and you will have to give them a small percentage in the form of commission for trading.
Penny Stock transactions are chargeable by brokers and there are many companies giving free stock tips.
Don’t just follow them and try to focus on your own decisions to get the right stock investment.
Penny stock investments are not too large and you can diversify your investments to get better profits.
Nearly 50% of the stocks are trading down 20% this year while some of them are trading down 70%.
There are many people who have actually made money through penny stock trading.
These shares are owned by companies having a small investment on major stock exchanges.
They can get large growth over the small rated investments but beware of pump and dump schemes associated with these stocks.
Penny stocks are not listed on major stock exchanges and lack proper information for buyers.
You need to be aware of OTC stock market or Pink Sheets listings and pick up a penny stock, which can probably give you good returns.
A significant portion of the penny stocks has revenue of less than one crore.
This raises the question about their business viability.
Nearly two-thirds of the penny stocks are making losses and the others make negligible profits.
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The losses of some companies such as RE agro and Nakuda are over 100 crores.
One of the penny stock Winsome diamonds and jewelry (Rs. 0.45) features prominently in the willful defaulter’s list and owes banks and financial institutions more than Rs. 2000 crores.
The above sets of data should conform to the investors that Penny stocks are very risky to trade especially when the liquidity is disappearing from the market.
PM Modi is looking for higher corporate taxes but the performance of penny stock companies this year indicates that his expectations will not be met.
One of the problems faced by these companies is the non-availability of liquidity and even if did it come with a high cost.
The banks prefer lending money mostly to big corporations and if any monies are left they would invest in the Indian government securities.
They don’t believe in the economic viability of these companies and shy away from lending to them.
The recent popularity of penny stocks reflects in part the sheer number of technology casualties since the stock bubble burst.
“In the last several years we’ve seen a number of legitimate tech companies that have been beaten down badly but then came back from a near-death experience.
Unscrupulous promoters have exploited investors’ ignorance in the past, using false or misleading statements to inflate the value of penny stocks, then cashing out before the companies’ true value — or lack of value — become apparent and the stocks tumble.
The process is so common that the authorities have given it a name: pump-and-dump.
One of the biggest advantages of investing in penny stocks is that they require a smaller initial investment.
Many of these stocks can be purchased for $.10 or $.20 per share.
This means that with only a few hundred dollars, you could be the owner of thousands of shares of stock.
This allows you to get started in the market even if you have limited capital to work with.
With a larger company, you may have to pay a few hundred dollars for a single share of stock.
This prevents smaller investors from getting involved.
With penny stocks, the market is open to virtually everyone.
People often confuse penny stocks with stocks in companies with poor fundamentals and operator drove scripts.
Ideally, the latter should be treated as fraudulent or bad stocks whether they are penny stocks or not.
It is true that most penny stocks may be easy for operators to drive the prices of, mainly because of:
(i) Low liquidity; and
(ii) Low market cap;
It does not, however, mean that investing in penny stocks is akin to investing in companies with low quality or poor fundamentals.
Another advantage of this type of stock is that there is large potential attached to it.
When you invest in this type of stock, there is a lot of room for growth in the company.
For example, let’s say that you invested $1000 into a stock that cost $.10 per share.
This means that you just purchased 10,000 shares of stock.
If the stock went up in value only $.05 per share, your investment value would grow to $1500.
This represents a 50 percent increase in your investment value.
On the contrary, let’s say that you invested the same $1000 into a stock that cost $50 per share.
This would give you 20 shares of stock. If the price went up only $.5 per share, you would gain only $1.
In order to make good money with larger stocks, the prices have to increase quite a bit more than they do with penny stocks.
Penny stocks have always offered a high potential reward for investors.
Although the risk is high, if you stick to the proper plan and invest in the right companies, you can minimize risk and maximize reward.
The largest barrier for a new investor is the myth that you need to have a large chunk of cash to make money.
Penny stocks allow you to invest with any amount as long as commissions do not reduce your profits in a significant manner.
For analyzing larger companies, there are many different moving pieces that require time and effort.
By investing in penny stocks, you can keep things simple and avoid wasting time.
The proper game plan of Striker Stock Research focuses on diversification, cutting losses and taking profits.
With any money management system, you can protect yourself from severe losses.
However, if the markets crash and you are holding large-cap stocks, there is a good chance your holdings will crash as well.
Smaller stocks usually have little to no correlation with the markets.
The protection from severe losses also applies to this point.
Large-cap investors have to be concerned with market risks as they could take a loss on a substantial pullback.
Penny stock investors usually see little to no correlation with the markets, resulting in less time spent worrying by a computer screen.
Penny Stock investments can be done online through various stockbroking companies.
You need to open a trading account, which can be loaded with money.
The transactions can be made with that account and you can make research over the companies into your consideration.
Penny Stocks require a higher level of investigation and you can get losses without making a right study for stock trading.
These stocks are generally highly speculative and high risk, trade in low volume and tend to exhibit significant price volatility – i.e., there is likely to be substantial variability in their pricing pattern.
As a result, investors should be ready for the possibility that they may lose substantial or their entire investment while investing in penny stocks.
Lack of Information
When you invest in large companies, you should be able to find an abundance of information about them.
You will not have to dig very hard to find financial statements or anything else that you need to examine.
However, when you invest in penny stocks, this may not be the case.
These companies will not be listed on the major stock exchanges, and you will find that there is less information about them.
Low-priced, small-cap stocks are known as penny stocks. Contrary to their name, penny stocks rarely cost a penny.
The SEC considers a penny stock to be pretty much anything under $5.
And while there are sub $5 stocks trading on big exchanges like NYSE and NASDAQ, most investors don’t think of these when asked to describe a penny stock.
The penny stock market is riddled with scams, pumps and dumps, and poor liquidity but it’s a heck of a lot more secure than the ICO market.
You can make really good money with penny stocks by understanding the business model of the company, their competitors, products/ services demand and the future prospects.
There are many companies depending on commodities or the other requirements in the generation of products or services.
Oil, natural gas, pharma and many other industries are blooming in penny stocks and they involve risk of fraudulent associates.
Penny stocks are actually difficult to sell because people fear to lose their money by investing in these companies.
There are many Pink Sheet investments having a lack of regulations and no reporting guidelines.
These companies can generally get manipulations and involve in ‘pump and dump’ schemes.
The prices may vary adversely and you can lose your money with the clever actions of counterfeit stockbrokers.
Penny stocks are vulnerable to frauds, but you can make the appropriate selection to win the battle against fake stocks.
If you tend to purchase stocks of some good companies, there is a probability to earn handsome amounts and get high ROI.
It is often seen that most companies that offer penny stocks are in the red or are on the verge of bankruptcy.
Moreover, the promoters of such companies are actually looking for ways to recoup losses by any means possible.
Moreover, one simply has no access to the company’s history or its performance in the past because they are new or the analysts have no reach to them till now.
The stock’s potential in the long run, therefore, becomes indeterminable because of the dearth of any historical information.
Some penny stocks, however, have given good returns, provided the investor has sold out at the opportune moment when the prices have risen, even at much higher expenses.
On the flip side, in most cases, the company often gets delisted and the investor ends up with “dead stocks”, that cannot be converted into cash or traded at all.
The company that offers such stocks usually is stingy with providing financial details by taking advantage of the fact that markets don’t insist on proper financial documentation.
There is simply no tangible information that helps the investor make an informed decision.
Furthermore, it has been seen time and again that the bulk of the information on micro-cap stocks emanates from non-credible sources such as spam e-mails or articles in financial dailies or magazines.
Here promoters of such companies actually use dubious methods to get false information across to potential investors.
Penny stocks, also called pink stocks, are also often subject to cons and manipulation to which the newbie and naïve investor fall prey.
Canny and fly-by-night stockbrokers often advise bulk purchases with promises of considerable returns on short selling.
The price increase is temporary through bulk buying, only to get the followings by a sudden and sharp decline which leaves the investor finally in the lurch.
With low liquidity levels, selling penny stocks at the drop of a hat may pose to be a problem.
One may have to lower his prices considerably for offloading even at the risk of a financial loss.
Moreover, a lower liquidity level provides opportunities to certain dishonest traders who apply the pump-and-dump technique by manipulating the stock price through the purchase of such stocks in bulk, jacking up prices and offloading in bulk again at attractive prices.
The severe lack of minimum standards in monitoring penny stocks is yet another notable disadvantage.
Pink Stocks are not necessary to fulfill the basic standard requirements to operate on an exchange.
Should the company be unable to maintain its superior position on any one major exchange, it can always move to a smaller exchange.
The thumb rule, therefore, is that one should never invest more than five percent of his capital in penny stocks, if at all.
Moreover, it isn’t wise either to put all your eggs in one basket and spend only that cash that you may be prepared to shed.
Penny stocks may trade infrequently – which means that it may be difficult to sell penny stock shares once you have them.
Because it may also be difficult to find quotations for penny stocks, they may be impossible to accurately price.
Investors in penny stock should be ready for the possibility that they may lose their whole investment.
While penny stocks generally trade over-the-counter, they may also trade on U.S. securities exchanges, facilities of U.S. exchanges, or foreign exchanges.
You should learn about the market in which the penny stock trades to determine how much demand there is for this stock and how difficult it will be to sell.
Be especially careful if your broker is offering to sell you newly issued penny stock that has no established trading market.
The securities you are considering does not have an approval or disapproval from the SEC.
Moreover, the SEC has not passed upon the fairness or the merits of this transaction nor upon the accuracy or adequacy of the information contained in any prospectus or any other information provided by an issuer or a broker or dealer.
Such stocks are very volatile to trade in.
Since their prices are so low, even a small increase/decrease in price can double or half the value of the investment.
Below mentioned are some precautions, which an investor should take before investing in penny stocks.
Get proper company information
It is difficult to get proper information about smaller companies, as they do not file their information disclosure with the stock exchanges, and there is not much information available in the outside circles as well.
Proper research is a key to successful investing in a particular penny stock.
The liquidity factor
Moreover, in most cases, the total market cap of such companies is very less which makes it even more easy to buy large blocks of shares in them which leads to volatility.
Penny stocks carry less liquidity, and this element is a double-edged sword.
The first issue is sourcing a buyer, as it is difficult to find a buyer for such stocks due to its high volatility rate.
The second problem is the pump and dump strategy.
Here the price of the stock increases when an investor buys a significant amount of capital.
Thereby creating a smokescreen where the stock gets strengthen.
After that, an investor buys it who find it attractive.
Pick out the better stock
While trading in penny stocks, it is a prudent move to find and trade in the stock with a credible background like a start-up or a small business with good financial history.
Find the gem in the rubble and invest in those stocks.
Hold on to those stocks and wait until there is a positive growth in the company or until there is a suitable buyer.
Do not get attached to the stock
Never get attached to the stock on the belief that it may suddenly rise.
Once you find the suitable buyer, you should sell out the stock so that you can get your money back along with some profit.
Even though trading in penny stocks is quite risky, there are investors who benefit from trading in penny stocks, as it is their occupational income.
Don’t believe the hype
When investing in penny stocks, research and know the maximum possible information and then take the decision for investment.
Believing the hype is not the right way to go about when buying penny stocks.
Many spam emails entice investors to invest in the penny stocks.
Beware of these emails and try to get the actual data to know the exact state of the advertised penny stock.
Lack of history or no history
Many companies that are floating penny stocks are the newly emerging companies or businesses nearing bankruptcy.
This factor leads to poor track record or no track record at all (if a newly created company).
This lack of history leads to the failure of determination of stock’s performance in the market.
Not governed by standards
Traders generally trade Penny stocks in the secondary stock market where there is a minimum requirement for submission and filing of documents.
Traders often trade the penny stocks over-the-counter through the OTC Bulletin Board (OTCBB) and pink sheets.
The pinks sheets have no such requirements and minimum safety standards.
These standards guarantee a certain level of security to the investors.
Before investing in penny stocks, it is prudent for the investors to go through the above-mentioned points, as penny stocks carry high risk and volatility, notwithstanding high returns.
I can safely say that in 90% + cases, operators recommend penny stocks after they purchase a huge quantity in them.
As I stated above, it is extremely easy to cause the price of such stocks to move up or down by a few percentage points.
A few small orders by a small number of retail investors will be enough to cause a 5-10% movement (or more) in the stock price.
This is the biggest risk comes with Investing in penny stocks.
Ideally, you must try to ignore immediately actionable tips and if you are planning to invest in penny stocks, do so with some amount of research and most importantly – before the stock recommendations start on online forums.
Holding your positions before a hysteria is most likely to go in your favor as you are most likely to acquire your holding even before the operator.
What Makes Investing In Penny Stock So Attractive?
Investing in penny stocks attracts investors for 3 main reasons:
They don’t cost much and you can buy a large number of these shares for very little money.
This gives the investors, a sense of holding on to something significant and sizeable.
Many small investors, who cannot afford to buy a substantial number of shares in a large company like Colgate, ITC etc, can easily afford to purchase 100 or even 1,000 units of such penny stocks.
It is true that if you manage to invest in a business at a really young stage, you are likely to be very rich if that business does well.
Investing in penny stocks could result in your acquiring a large percentage of shareholding in the company at a time when not many investors are holding its shares.
Small Movement Gains –
Even a small increase in a price can translate into a sizable profit.
For example, a single rupee movement for a stock trading at Rs. 2 (which appreciates by Rs. 1 to Rs. 3) translates into a 50 % return on investment.
On the other side, if an Rs. 125 or Rs. 150 stock increases by Rs. 1, the increase in your total investment would be just 0.80% and 0.67%, respectively.
Given the risks associated with such stocks, can you cash in on the potential growth of these stocks?
There are some basic rules that you need to follow while picking a penny stock.
That is to give yourself the best chance of making good returns from your investments.
Rules To Remember when Investing In Penny Stocks
Don’t invest in just 1 or 2 penny stocks –
When it comes to investing in such stocks, remember one basic rule.
“No matter how correct you may be, in all likelihood, a majority of these companies will disappear and you may destroy your wealth by 100%”.
Diversification is far more important here than it is when you invest in any other type of stocks or asset class.
Create a portfolio of at least 12 to 18 penny stocks if not more.
Watch the trading volume –
Such stocks are normally illiquid.
If you want to buy a large number of such stocks make sure that the stock has good liquidity.
It is important that you study the trading volume very closely, at least for the last 6 months.
Focus only on buying shares where you see a high volume of trading.
Research the Underlying business, financials –
Don’t forget to do your own research about what the company does and into its financials.
You should pay the same amount of attention and diligence.
As you would before investing in any large or mid-cap company, if not more.
Sometime back I wrote a post on things to look.
That is before investing in a company where I spoke about some of these points.
Time your trades –
If your stocks are performing well and are significantly up from your purchase price then sell your stocks.
Further, take your profit unless you realize that the appreciation was not a result of any operator activity.
Also, feel that the underlying business has indeed better than before.
Or doing well and that this was likely to continue in future.
Strict stop-loss targets –
Stop-loss orders are necessary to protect you from shares which fall significantly and quickly.
Work with very strict stop-loss targets.
Don’t live in the hope that a stock cannot go down from a particular level.
Avoid the Forums –
Avoid investing in penny stocks on the basis of what you read or hear on chat forums and free message boards.
In almost 100% of cases, they serve as the hunting ground of operators.
Whose very job is to generate interest in such stocks after acquiring a large stake in an underlying stock.
Often this happens in concert with the management of the company.
Which acts in concert with such operators in trying to create interest in the stock.
Even though investing in penny stocks can be very lucrative, it can cause many problems as well.
This type of investment carries with it a great deal of risk as well as opportunity.
In the previous example, it would take the penny stock’s decreasing in value.
That is by only $.05 per share for you to lose half of your investment.
This makes investing in the penny stock market a very speculative type of endeavor.
The only effort required for investing in penny stocks comes from developing a game plan.
That is for execution and conducting the analysis.
Striker Stock Research game plan provides investors with both.
So, you need to put only the minimal effort while you profit from our recommendations.
If you conduct your own research, be sure to have some sort of systematic approach.
That is in order to avoid leaving your comfort zone.
Overall, there are many reasons to invest in penny stocks.
But the largest incentive is to take advantage of high reward investments with the need for minimal effort.