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- Category: Stock Market
Do you know the meaning of the penny stocks?
What are penny stocks?
The explanation is in the name, actually.
Penny stocks are those which sell at a very low price, have very low market capitalisation, and are usually listed on a smaller exchange.
In the western market, shares that trade below $1 are usually called penny stocks. But this basket also includes stocks priced under $5.
Penny stocks in the Indian stock markets generally have prices below Rs. 20.
Yes, you heard right.
So, one share of one of these companies will cost you less than a large sized Cadbury Dairy Milk.
Something to think about, right?
So, if any of you out there had been putting off investing in the share market due to insufficient funds, you really don’t have enough of a reason anymore, do you?
Of course, these ridiculously low priced stocks do not come without baggage.
Penny stocks are generally considered highly speculative and involve an inordinate amount of risk because of their lack of liquidity, small capitalization and a variety of other reasons. Very simply put, the companies in question are so small that they are not very stable. This leads to movements of gigantic proportions when it comes to price of the shares.
Penny stocks are highly risky, but they do have the potential of turning a small investment into a fortune. For example, if you own 50,000 shares of a penny stock priced at Rs. 10, even a Re. 1 rise in the share price can give you Rs. 50,000 in a single day. Of course, a Re. 1 fall could also cost you Rs. 50,000 in a single day, but what is life without a little uncertainty, right?
If you’re getting excited about penny stocks, it might be a little premature.
You should watch this video to know more about penny stocks.
Before you start investing in penny stocks, there are a few things I should probably tell you.
TIP 1: TAKE OFF THE ROSE TINTED GLASSES
Penny stock promoters are quick to sell you stories about companies that are poised to blow up and change the world with their products.
DO NOT BELIEVE THEM.
If penny stock companies were legit companies, they wouldn’t have been penny stocks. They would be higher priced stocks, not pocket change.
Most penny stock companies are ultimately going to fall. So the odds that you will be able to figure out which lucky few will grow in future are, let’s face it, very slim.
So stop believing everything that you hear and recognize the realities of penny stock trading. These companies may all be untrustworthy, but that doesn’t mean you can’t use them to make some money.
TIP 2: ADJUST YOUR PROFIT EXPECTATION
Another big piece of hype you’ll hear from penny stock promoters has to do with how quickly your money can grow.
Yes, it is possible that a penny stock will grow from Rs. 10 a share to Rs. 20 a share, and it’s possible that you may double or even triple your money in less than a month.
The chances of that happening are astronomical.
Instead, you should try to adjust your expectations to a smaller, more reasonable profit margin on each trade. That way, you will be able to avoid major losses and disasters.
If you’re constantly chasing big wins, you’re going to force trades that aren’t really there. And it’s these kinds of mistakes that’ll take you out of the game before you even have a chance.
TIP 3: RESPECT RISK
As I mentioned before, most of the penny stock companies aren’t worth the paper their stock certificate is printed upon. Penny stocks are thinly traded and can be hugely volatile. Both these factors mean that things can change very quickly.
Now the question is why penny stocks are so much risky:
Here’s the answer,
1) Penny stocks can be easily manipulated by brokers/promoters
2)These types of stocks are generally considered to be highly speculative and high risk because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following and disclosure.
3) BSE has already flagged these stocks by putting them in separate groups and is certainly not responsible if investors take risks knowingly.
4)Traders & brokers may easily use ‘PUMP & DUMP SCHEME’
5) Liquidity: Several Penny stocks generally trade at low volume. Means if you want to sell and come out, there might not be any buyers.
You can see in the image above that the price and volume of Surana Corporation Limited on 10 February 2017 was Rs. 1.25 & 10,000 respectively. Even the price of the stock on 10 February was just Rs. 1.25 still the volume was very very low.
Hence invest in penny stocks that has high volume so that you can liquidate if required.
A stock that you think is on it’s way up can tank in a few minutes. A stock that you think is a surefire short sell can reverse course in the blink of an eye.
The bottom line is you just don’t know what you’re dealing with when it comes to penny stocks. That press release you saw about a company’s new technology could be legit, or it could be a complete lie dreamed up to pump and dump the stock.
You can’t fight this risk, but you can respect it.
Make sure that you haven’t committed too much of your portfolio to a single play, and make sure that the position you take isn’t large enough to affect the stock’s price action. Always watch for good liquidity. Ideally, at least a few lakh shares traded daily as reasonable trading volume is the only way you can be reasonably sure you’ll be able to get in and get out as needed.
Sounds easy enough, right?
It is, really.
I know I’ve been giving you too many warnings, but one can never be too cautious when it comes to penny stocks.
Let me tell you a little bit about how people generally make profits.
Traditional stock traders buy low and sell high. The smarter ones take things one step further, both buying low and selling high, and then selling short when prices begin falling and buying to cover. This lets them make a profit both on the way up and the way down.
As exciting as this prospect sounds, there is something you need to do first.
You have to be able to find penny stocks before they spike.
If you want to be able to go long and sell short, you have to be able to identify when a stock is spiking. If you don’t know that it’s going up, you’ll still be able to sell short at its peak, but then you’re only getting half the profits. And if you can’t tell when the peak is happening, you risk getting squeezed on the position you’re holding long.
Basically, being able to tell when a spike is happening is pretty important for a penny stock trader.
Unfortunately, there’s no 100% guaranteed rule that will tell you what a stock will do, but there are a number of signals you can watch out for.
RULE 1: Piggyback on stocks that have already spiked a little
One of the quickest ways to find a spike in the making is to start by finding a stock that’s already moving.
Think about it.
Which would you rather do?
Sit around staring at empty charts, waiting for breakouts to appear out of thin air? Or would you rather use the many research tools out there to find a stock that is already moving?
So like any rational person, you would obviously pick the latter option.
RULE 2: Do your own research
I hate to say this, but a big reason most penny stock traders fail is because they’re lazy. They don’t want to do the research. They want someone to tell them what to do. They are the ones who resort to random tips from unreliable sources and they are the ones to crash and burn.
Are you still gung ho about penny stock investing?
Before you select which stocks to invest in, keep the following things in mind.
- Make sure they are not companies that vanish overnight. Instead, go for the ones that have been around for a few years
- They need not strictly be penny shares; they should cost less than Rs. 25
- Their products or services must be real and visible
- They must have some downside protection in short-term
I can give you some more examples about penny stocks in India to further enhance your understanding.
- Kumar Wire Cloth: In the year 2015-16, Kumar Wire Cloth gave a magnificent return of 3143% over 2014. It showed high sales values although the profits were low.
- Cambridge Technology: Cambridge Technology is a small IT company stock. It gave a return of 1866% in one year. This company turned out to be the best penny stock of 2015.
- Virat Crane: This company manufactured dairy products. This penny stock gave a return of 539% over the course of a year.
- White Diamond: White Diamond deals in apparel accessories. This company gave a return of 275%.
- RT Exports: RT Exports deals in agricultural products. This particular stock grew by 164% in 2015.
The above table shows a list of penny stocks which have given more than 100% returns in less than 150 days.
Sounds like a dream come true, right?
Penny stocks is a high risk high reward gamble. Very few penny stocks have the capability to do the best. You’re risking your money in a company with questionable management in order to make a profit. If you’re ready to take that risk, then penny stocks are ideal for you.
But as the above numbers show, penny stocks are also very VERY profitable. So study properly, do your research and think hard before investing.
I hope you understand what penny stocks are and the risk associated with them.
Don’t be fooled by people telling you that every company was once penny stock & every company’s stock is penny stock at the start, as it depends upon its IPO price band and performance.
Don’t buy any penny stocks blindly in the hope of large and quick profits & thinking that these stocks will go up one day, first, you should look at why the stock became penny as there must be reasons these stocks trade at such low prices.
Do you invest in penny stocks?
Share your experience.
And if you want to mention something else or if you want to express your opinions, feel free to leave a comment. Happy trading!