Penny stocks grab the attention of many investors for plenty of reasons. To invest in penny stocks, you do not need plenty of capital. Having more flexibility in terms of having to invest lower capital allows many to enter the landscape of investing. While there is the benefit of investing lower capital, making high profits with penny stocks can be a challenge. In this article, we will have a look at the details of penny stocks and the parameters you should consider before investing in penny stocks.
What are Penny Stocks?
Penny stocks are stocks in the share market that are available for very low prices. These low prices are alluring thereby leading to many investors with low capital availability to invest in such stocks. Penny stocks have high volatility. This is a fact that concerns many investors. With such volatility, it is possible to lose all of the money that you have invested in penny stocks. The main reason behind this is that penny stocks whose share price is very minimal have experienced a major downfall. Such low prices would be a result of a multitude of factors such as poor products and services. However, there is another side to penny stocks as well. There have been several penny stocks that have grown to become multibaggers over time.
Penny stocks have low market capitalization. For instance, consider stocks that are valued less than ₹10. Such stock definitely has lower market capitalization than blue-chip company stocks that range between ₹700 and ₹1,500. These stocks also lack liquidity. In addition, they also carry an increased level of risk as they trade in such a low volume.
How to Trade Penny Stocks?
While beginning to trade penny stocks, it is best to start with research. Research all you can about the stock including its fundamentals such as its P/L statement, management, advisory board, previous years’ performances, etc. Once you gain a certain level of understanding of a penny stock, get comfortable with paper trading these penny stocks. In contrast to other equity stocks, the price movement of penny stocks can vary. The safest way to trade penny stock is by practicing to handle price fluctuations and patterns through paper trading. Once you master paper trading, it can be best to trade in the live market with money.
How to Ace the Penny Stock Game?
To make the right choice about penny stocks, there are certain factors that you have to consider. Let us have a look at the 5 key factors that can help you determine the winning penny stocks that can fetch you potentially great earnings.
Understand the Market
You will first have to begin with understanding the stock market as a whole. There are several different factors that drive the stock market such as economic conditions, recent news, the launch of products by a company, performance of a particular sector, etc. You have to gain a deep understanding of all these factors, to begin with. Once you gain a better understanding of the stock market, you will be able to choose the right penny stocks.
The stock market has plenty of smallcap funds. So, when you are on a quest to identify penny stocks, you will come across hundreds of options. Researching penny stocks is different from the method that you can use to research mid-cap or large-cap funds. With penny stocks, you will first have to create a wide list of sectors to pick stocks under each one of them. Then, make a list of criteria that suits your investment needs. Continue to filter the penny stock list using your criteria.
To understand your level of preparedness, you can start paper trading penny stocks. Paper trading involves watching the stock market closely and trading a hypothetical list of stocks without investing actual money. You can maintain an online or an offline record of your paper trading activities to observe and learn from your mistakes.
Gain Insight on Valuation
Many investors are attracted to penny stocks as they are low in value. However, this measure is not the most accurate measure that can help determine the rewards you can get. Buying more shares due to low share prices does not translate to higher rewards. Let us consider an example. Assume that you buy shares from Company ABC and Company XYZ. They have share prices of ₹10 and ₹50 respectively. Consider that you have ₹5,000 to invest in the market.
With this capital, you would be able to buy 500 shares in Company ABC and 100 shares in company XYZ. While the number of shares you hold in Company ABC might seem higher, it does not necessarily have to offer a higher valuation. You can identify the valuation through parameters like P/E ratio, book value per share, and others. The book value per share helps you gain insight into the intrinsic value of the share depending on the performance of the company. You can get this value by dividing the net worth by the total number of shares. To calculate the P/E ratio, you can divide the stock price of the company with its earnings per share.
Keep an Eye for Constant Dilution
The main aim behind companies offering shares is to raise capital. Large companies raise capital to meet their operational costs, expand, etc. In some cases, small companies raise capital to issue a certain portion of shares to employees and new talent. This would lead to dilution of the company and decrease the share of shareholders in the company. Ultimately, the management of the company would continue to change frequently thereby leading to instability.
Penny stocks can be attractive as very minimal capital is required to invest in these stocks. While they have the advantage of minimal investment capital, they also carry certain risks. It is important to understand if penny stocks will suit your investment style as well as your portfolio before moving ahead with investing in these stocks. There are many penny stocks to buy. Make sure that you choose the right one.