Many investors know what penny stocks are but are not very open to trade in them. Why is that? The common notion in the market concerning these stocks is that they are highly volatile and the benefits are not worth the effort.
However, ever try asking a veteran who has been investing in the market for years about penny stocks, that’s when you will get the actual advice on penny stocks.
The entire concept of penny stocks comes from the western market. The traders of the west called the stocks of smaller companies which traded for less than $1, penny stocks.
And the prejudice of not trading in them also came from that time itself. The traders believed that when trading in penny stocks, the commission paid on each transaction, when compared, actually came higher for such low-valued stocks. Thus, people began avoiding penny stocks.
But, when a few investors trysted their analysis and started investing in these stocks, they realized that penny stocks can become multi-baggers.
Now, many traders actively look for penny stocks that can grow into profitable investments. Let’s get to know more about these stocks.
What are Penny Stocks?
In the Indian market, penny stocks are any stock that has a share price of less than Rs.50. And it is quite understandable that if a share price is less than Rs.50, it will of a small-cap or micro-cap firm.
There is one drawback of these stocks and that is they are illiquid since the market considers them to be volatile.
It is clear that penny stocks belong to small-cap firms, but what characteristic makes a firm fall under the category of small-cap firms?
- Large-cap firms: Large-cap firms have a market capitalization of Rs. 20,000 Crore or more.
- Mid-cap firms: Mid-cap firms have a market capitalization Between Rs. 5,000 Crore – 20,000 Crore.
- Small cap firms: Small-cap firms have a market capitalization of Less than Rs. 5,000 Crore.
Now, the above information clears up that any firm with a market capitalization of less than Rs. 5,000 crores will be classified as a penny stock.
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Other factors used to classify Penny stocks
Although a share selling for less than Rs. 50 is referred to as a penny stock in India. However, even Rs. 50 is not that inexpensive.
A stock’s price by itself cannot accurately indicate whether it is pricey or inexpensive. Before making a choice, certain other factors also need to be considered. A few examples of the parameters are:
- Growth prospect of the stock
- Book value of the stock
- Amount of debt in the books
- Price-to-earnings ratio
Features of Penny Stocks
If any stock seems to be a penny stock, before actively trading in it, check for the following features in it to be 100% sure about it.
This feature is self-explanatory. As mentioned above, these stocks are traded cheaply. With this feature, the investors have the benefit of being able to hold a considerable stock in a small-cap firm without investing a big chunk of money.
Illiquidity is a feature possessed by companies that are less popular in the market and have less trading volume. Thus, automatically, traders trading in such shares find it difficult to locate fellow traders readily taking an opposite position.
They are bound to be risky because of illiquidity and high volatility in proportion to market conditions. However, you can be assured that if you can find a gem of penny stocks, the risk will get compensated with high returns.
Many small-cap companies have a lot of potentials to grow into bigger profitable firms. Compared to alternative investments, these stocks do promise quite a good amount of returns on the risks taken by you.
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Few more reasons to invest in Penny stocks
If analyzed properly, you will be able to find your reasons to invest in these penny stocks. Some of these are listed below:
Cheap but multi-baggers
One of the best things about these stocks is that penny stocks are cheap.
Meaning if you buy some of these shares and make them a part of your portfolio, the volatility that comes with these stocks will get mitigated by the other stocks and when the market favors, the penny stocks will provide high returns.
Multi-baggers but cheap
It start as cheap stocks but many times a few years down the line and the company starts getting recognized as a large-cap firm.
Thus, if you can identify such stocks in the market, then you can become part of a multi-bagger company in the future by only investing a small amount today.
Who knows, a company may be trading as a penny stock today but develop into a large-cap stock in a few years, thus keep a close lookout for such stocks.
Who Should Invest in Penny Stocks?
In general, these stocks are open to every market participant, however, the decision to put your hard-earned money into it depends on your financial objectives and risk appetite.
Trends have shown that investors who actively trade in these penny stocks are the ones who are seeking risks. They are the investors who are more inclined towards taking risks than looking for profits.
Thus, if you are also part of this adventurous group of investors, feel free to start your journey of finding the best penny stock today and wait till it brings you high returns in the future.
However, do keep in mind that you should only invest in these stocks when you trust your analysis and not because any peer is telling you to trade in them.
If not confident, then try exploring a few other options before you are comfortable trading in penny stocks.
Risks involved in Penny Stocks
Below are two major risks are mentioned which you might have to be prepared for when getting involved with penny stocks:
Less Public Information
Since penny stocks belong to less popular companies, it is possible that the media may not cover a lot of information on these stocks.
Thus, you might have to do an extensive level of research to analyze their financials and growth opportunities.
Penny stocks are cheap but what if a whole crowd of traders suddenly starts taking interest in these stocks? This will automatically raise the price of the stock because the demand for it will go up.
And as the price rises, many traders will notice this change and start buying it. This will further raise the stock price. Now few traders who hold a considerable amount of the stock will try to raise the volatility and start selling their holdings leading to a sudden drop in the price.
The parties who sold the stocks will enjoy the profits but other traders will face the repercussion of the falling prices.
When it comes to penny stocks, you can expect a good return, however, you will also have to stay vigilant and keep tracking the market to know if there is any chance of sudden price fluctuations.
If you are looking for some thrill in your trading experience, try investing in penny stocks. Start with a small amount if you are not very sure, and slowly increase the bid and experience the joy of earning big profits when it converts to a multi-bagger.
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