What are Penny Stocks & How to Pick Them?

Have you ever visited a flea market when on holiday at a resort destination? You will have noticed that there is a huge variety of low price souvenirs and trinkets on offer, but you do usually need to check these to ensure that they are of good quality. Buying penny stocks is something like shopping at the stock market’s own little flea market. You get low share prices, but you need careful evaluation.

Penny stocks come from companies with essentially 3 criteria:

• Low market capitalization, usually less than Rs 50 crore
• A low share price, typically Rs 10 or less.
• A small volume of shares on the market

While the low price may seem attractive, if you are considering buying penny stocks, it is imperative that you have a thorough understanding of the risks involved, and know how to evaluate their potential worth.

What are Penny Stocks?

Penny stocks refer to shares of companies below ₹10. These stocks are often associated with small-cap companies and can be highly speculative. Investors should exercise caution, as they may lack liquidity and be more susceptible to price manipulation.

Features of Penny stocks

Penny stocks exhibit distinct features that investors should be mindful of:

• Lack of Liquidity: Penny stocks are frequently plagued by means of a loss of liquidity, indicative of sporadic trading and a constrained pool of customers and dealers. This shortage of market hobby now not simplest complicates the fast sale of stocks but additionally contributes to vast and unpredictable charge swings, requiring investors to work out caution and strategic planning.
• Return Potential and High Risk: Even as penny shares tantalise buyers with the promise of tremendous returns, their attraction is coupled with a heightened degree of risk. Acknowledging that tremendous outcomes are not assured for all penny shares, buyers need to approach those investments with an eager focus on the capacity for value decline over time.
• Opportunities for Multibaggers: A few penny stocks entice investors with the possibility of turning into multi-baggers, meaning that their value will increase many times above their initial purchase price. However, this alluring possibility necessitates a measured response, highlighting the significance of diligence and cautious thought in the face of uncertainty.
• Pricing Unpredictability: Penny stocks often grapple with unexpected and unpredictable rate fluctuations, posing a formidable task for buyers seeking to forecast their market behaviour. This volatility is intricately linked to numerous elements, which include broader market dynamics, enterprise-precise information traits, and shifts in overall investor sentiment.

Navigating the landscape of penny stocks calls for nuanced information on those features. While the ability for massive gains exists, investors have to tread carefully, considering the inherent dangers, pricing dynamics, and the speculative nature of those shares earlier than incorporating them into their investment portfolios.

Advantages of Penny stocks 

• Volatility and Potential Gains: Penny stocks are highly volatile but offer the potential for attractive profits, attracting investors seeking rapid growth.
• Low investment, excessive Returns: Despite minimal investment, tremendous income is viable, permitting individuals with restricted capital to personal thousands of stocks compared to conventional blue-chip shares.
• Rapid Growth Potential: Unlike established stocks, which may take years to reveal sizable gains, penny shares can experience sizable rate changes within days, providing possibilities for brief returns.

Not all stocks exhibit rapid movement. It’s crucial to understand that not all penny stocks demonstrate swift price movements, and investors should carefully analyse potential candidates before making decisions.

Disadvantages of Penny stocks

• Liquidity Challenges: Penny stocks face difficulty in selling due to limited liquidity, hindering holders from easily cashing out.
• Low trading Volumes: Penny shares are often traded in low volumes and are greatly at risk of market manipulation and sudden price fluctuations.
• “Pump and dump” Fraud: The “pump and dump” approach includes artificially inflating percentage fees, deceiving investors and growing false representations approximately a corporation’s function, constituting a shape of fraud in the microcap inventory marketplace.

Why do investors buy penny stocks?

The main attraction of penny stocks is low capital requirement. Investors are able to get stock market exposure at a very low price. Some penny stocks trade for even less than Re 1 per share.

Eg. Maharashtra Corp traded at Rs 0.50 on 8 July, 2021. Gold Line Int. opened the day at Rs 0.27 per share.

Another bone of contention in favor of penny stocks is the potential growth prospect they present given the catch-up space they have with large-cap stocks, or even small-cap stocks.

What are the risks involved in buying penny stocks?

Penny stocks are high risk investments because:

Financials and other fundamentals – Because penny stocks come from companies that are not very sizable, investors have a challenging time getting hold of trustworthy data to conduct fundamental analysis of these companies.

Compliance to norms – Another potential risk arising out of small company size is that they might (due to oversight or simply lack of expertise) find themselves embroiled in regulatory issues. Investors stand to lose out should such a stock be suspended from trading by the regulator, that is SEBI.

Illiquidity risk – Low market cap directly corresponds to a low number of shares being traded on the stock market. There is a high chance that there may be no interest in these stocks and they may become illiquid and remain so for extended durations until investor interest revives.

Manipulation of stock price – Low volumes is a ripe situation for manipulation. For example, the price of the penny stock might be set up to soar by purposefully buying a large volume of the shares on the market, or the price can be made to tumble drastically by dumping stock in large volumes. It is possible to achieve large enough volumes to manipulate the stock price because there are fewer shares on the market.

How to pick penny stocks

Investors should pick penny stocks after conducting their own fundamental analysis and thorough technical analysis.

Evaluate using technical analysis

You must wrap your head around technical charts and indicators in order to make observations linked to the share price of the penny stock. You need to watch for 2 things.

Overall patterns:

You should be able to understand the patterns of dips and spikes in the share price. Train your eye to observe patterns that appear in the stock graph. For example –

• You will notice that while the price fluctuates continuously, there might be a particular price band between which the price fluctuates – at least during a certain period.
• You might be able to notice that the share price of a penny stock is on an uptrend, or alternatively on a downtrend.

You need to observe (at a minimum) a 3-month to 6-month price chart before you are ready to invest in a penny stock. Investors typically play it safe and try to buy when the price is closer to the 6-month low and sell when the price is at a 3-month to 6-month high.

You can learn all about technical analysis right here on the Angel Broking investor education resource.

Volume

After overall stock price patterns, the second factor to consider when evaluating penny stocks is volume. Volume takes on absolute significance when trading penny stocks. Observe how volume is affecting the price volatility.

Secondly, consider the volume of stock that you will purchase based on the average daily and monthly trading volume. You do not want to end up with 1000 shares if only 65 are bring traded per month.

Conduct independent research

Over and above evaluation of penny stocks using technical analysis, you should do what you can to track down the company’s historical financial data. Investors should verify the authenticity of data received in these small companies because there have been cases of audited results being doctored. Avoid being swayed by any “guaranteed tip”.

The best performing penny stocks can be identified using technical analysis – if the numbers display lacking potential, most investors would prefer to steer clear.

Also Read: Best Penny Stocks To Buy In India

Conclusion

When buying penny stocks, investors need to avoid emotional trading at all costs. It is easy to be swayed by greed with irresistible buy in prices, but investment should always be about calculated risk and investment goals. Investors should consider their risk appetite and the risk-reward ratio of any stock market investment, but all the more so for penny stocks because of their high risk nature.

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FAQs

How long should you hold penny stocks?

The holding period for penny stocks varies based on individual goals and market conditions. Due to their volatile nature, some investors may adopt a short-term strategy, aiming for quick profits. Others with a higher risk tolerance may choose a longer-term approach, monitoring the stock’s performance over months or even years for potential gains.

What is the range of penny stocks in India?

The term “penny stocks” in India typically refers to stocks under ₹10. However, the precise range can vary, and one-of-a-kind traders or market contributors might also use barely specific standards to categorise shares as penny shares based on their own preferences or risk thresholds.

How to buy and sell penny stocks?

To buy penny stocks, research potential stocks, open a brokerage account with reputed brokers like Angel One and place a buy order. Monitor stock performance regularly. To sell, set goals, place a sell order on your brokerage platform, and review associated fees. Implement risk management, diversify, and stay informed due to the inherent volatility of penny stocks.

How to find penny stocks?

Discovering penny stocks involves using stock screeners, checking exchange listings, and exploring financial news, forums, and social media. Utilise brokerage recommendations and create watchlists for tracking. However, be careful, conduct thorough research on companies, and consider potential risks. Due to their volatile nature, careful analysis and informed decision-making are essential before engaging in penny stock investments.