What is Penny Stock?
Penny stocks are stocks which trade at a very low price. Initially in western markets penny stocks were valued at less than one dollar. Over the time the term ‘penny stock’ has evolved. Now the U.S. Securities and Exchange Commission (SEC) have modified the definition to encompass all shares that trade below $5. In Indian market penny stocks are generally priced below Rs. 10. Factors like lack of liquidity, smaller capitalization, large bid-ask spreads and limited disclosure of information make these stocks highly speculative in nature. As they are very risky it is advised that the average investor should not invest in penny stocks. However, some of them have the potential of getting fantastic returns.
Things to Consider Before Buying Penny Stocks
- Never invest a large amount: Although penny stocks can turn a small investment into a fortune it is risky at the same time. Do not invest a huge amount in penny stocks. You should never invest more than 10% of your total value of shares. Suppose you have Rs 5 lakh in stocks, so the maximum amount you should invest in these stocks is Rs. 50000. You should only put the amount you can afford to lose.
- Invest only in a handful of stocks: Instead of putting your money in a number of penny stocks, it is advised to make investments in only 2-3 stocks. It will be easier for you to monitor those 2-3 stocks.
- Do not forget after investing: You should not keep investing in penny stocks for a long time. Putting money in penny stocks should be your short-term tactic not a long-term strategy. Make your exit at the right time after achieving your target. Some investors tend to think that if they wait for a year or so they will gain tax free returns. Usually what happens is that by that time the stocks fall.
- Do not trust anyone: You can find hundreds of financial portals online which are filled with advice and information regarding penny stocks. Do not get manipulated by those portals. Remember, investors are always searching for fools who will make investments for the junk in their equity portfolio. Do not get fooled by the rosy picture they paint.
- Invest in stocks with high volumes: There are some penny stocks which are traded very thinly. It is difficult to sell these high-risk stocks when you want to exit the stock market. Buy stocks which have reasonably high trading volumes so there is no lack of liquidity. Always consider the monthly average before buying stocks.
- Never try to average your purchases: Suppose you bought a share at Rs. 8 which is trading at Rs. 4 now. You should never buy more shares with an intention to average out your purchases. You might end up losing more money by doing so. If you want to improve the average then you should sell some shares when the price moves up.
- Always maintain your strategy: Do not let success change your strategy. You should not get carried away by success. Try to maintain your strategy no matter what the result is.
Most of the time investment in penny stocks goes horribly wrong by leaving investors bankrupt. So it is advised that the average investor should do extensive research before making investments in penny stocks.