What are Penny Stocks and How to Choose Right One?

Penny stocks are an intriguing area of the stock market - not so much in terms of transparency or liquidity, but for their potential to soar with a timely rumor. What's allure in penny stock investing lies beyond financials; sharp price swings provide an opportunity for quick profits. Their low liquidity level means that news about those companies can cause drastic price movements - up or down. Here you can learn to play your cards right and claim great rewards.

 

Penny stocks may seem like a bargain - but caveat emptor! Despite the higher potential returns, these low-price securities clearly require your careful consideration. The discounted price tag of penny stocks often reflects their increased volatility and lack of liquidity, making for an adrenaline-filled ride if you choose to invest. Are you ready to roll the dice?

What are Penny Stocks?

Penny stocks are often seen as the wild card of investments and are known in some circles by their microcap moniker. They are usually traded for less than Rs 50 per share on the stock market and involve a more significant risk than other stocks. Put simply; they are shares of small companies that trade on the stock exchange at meager prices. Though a penny stock may only cost a few cents per share, investors often purchase large quantities to make significant returns when such stocks skyrocket in value.

Investopedia defines penny stocks as "the common stock of tiny companies that typically trade outside the major market exchanges" (Investopedia, 2022). Many penny stocks don't need the listing requirements mandated by the major exchanges. So instead, the investors turn to the over-the-counter (OTC) market. The OTC markets group has designed a sophisticated system that categorizes securities into different tiers based on quality, transparency, and investor interaction. As such, investors can feel confident in the integrity of these marketplaces before investing. To determine what stocks to trade, use screening tools like the one found in the OTC market.

How Penny Stocks Work?

Once a company meets all the criteria mentioned by the Securities and Exchange Board of India(SEBI), its shares will be available to trade in the public market. Indian stock exchanges have different segments for securities trading and penny stocks are often included in the "Z" category which is reserved for companies with very low capitalization or liquidity issues. The Bombay Stock Exchange (BSE) offers a platform for trading penny stocks and other securities, while the National Stock Exchange (NSE) provides a platform for trading only securities that meet SEBI's criteria.

Are penny shares more volatile?

For several reasons, penny stocks are more volatile than other types of stocks. Look at the following reasons responsible for their incendiary nature:

  1. Firstly, because they are unlisted and traded over-the-counter (OTC), there is less transparency concerning the underlying company's financials. It increases the risk investors may take when investing in these stocks as less information is available to assess the company's performance.
  2. Secondly, penny stocks usually have lower levels of liquidity (i.e., fewer investors are trading in and out) which can lead to sharp price swings as news about the underlying company circulates through the market.
  3. Lastly, many penny stock companies are either very small or unprofitable, so their share prices can be sensitive to news and rumors, leading to very volatile prices.

    Penny stocks have been known to ignite the imaginations of investors with their volatile behavior.

    Are Penny Stocks Worth it?

    Penny stocks are, in fact, volatile, high-risk investments. But, these little gems have been known to shoot up in value and reward investors with returns bigger than their wildest dreams – if you know how to pick them out. With careful selection and knowledge of small-cap companies, you can make huge gains from penny stock investing while diversifying your portfolio like an expert investor!

    Rewards of Penny shares:

    Penny stocks can be a great way to diversify your portfolio and increase profits from stock investments. If done correctly, investing in penny stocks can bring about many rewards, including the potential for high returns on low capital.

    1. Low-entry barrier : Compared to larger and more established companies, the low cost of penny stocks means that you can get started investing with much less capital. You don't need a large sum of money to begin investing in penny stocks, making them attractive to investors who may not have the resources or experience to get involved in bigger stock markets.
    2. High Potential Returns : Penny stocks can offer much higher returns than traditional stocks, as they are more volatile and often move quickly in price. You could make significant profits if you can identify the right penny stock at the right time.
    3. Quick Investment Decisions : Unlike larger companies, which need to go through a series of approvals before any decision can be made, penny stock companies primarily operate under the radar. It means that they can make decisions quickly and easily, which could give investors an advantage in profiting from short-term opportunities.

    Here is an example of a penny stock that did well. Investors in Tine Agro and Kaiser Corporation are reaping huge benefits, with the two agri-products trader and printer scrip recording 725%/720% gains. Following a surge to Rs 31.8 on March 7th from its Dec 2021 baseline of Rs 6.8, it's clear that savvy investors have identified serious potential for growth within these companies.

    Risks of Penny shares:

    1. Pump-and-dump schemes : These refer to when someone buys a large number of stocks and then promotes them to the public to push up stock prices. When the stock prices become artificially high, they sell their stocks and make a profit while leaving other investors with worthless assets.
    2. Insider Trading : Insider trading is another risk associated with penny stocks. It is when people within the company use their insider knowledge to buy and sell the stock before the information becomes public.
    3. Low Liquidity : Liquidity refers to the ability of a market to facilitate buying and selling at any given time. Penny stocks might have low liquidity due to the low trading volume and lack of buyers and sellers. As a result, finding buyers or sellers for your shares at any given time may be difficult, which could result in losses.
    4. Lack of Regulation : Penny stocks are not regulated by the Securities and Exchange Commission (SEC), which means 
    5. Lack of Public Information : Compared to more extensive stocks, fewer analysts often cover penny stocks and less information available to the public. It means that investors may not be able to get a complete picture of the company's financial position or prospects.

    In 2018, Indian regulators SEBI and NSE were shocked to discover a troubling scheme involving Transgene Biotek Ltd. - its promoters had been utilizing pump-and-dumps tactics to fraudulently inflate share prices without informing investors about the company's financials. Unfortunately for many involved, these fraudulent practices cost them nearly $4 million overall - underscoring the need for tightened regulation of penny stocks across India.

How to Choose the Right Penny Stocks

Regarding penny stock investing, prudent decision-making and various factors can help determine the best stocks and enable you to make the most out of your investment.

  • Track the price behavior of Penny stocks : While they are known to be volatile, tracking their price behavior can alert you to any significant changes in their prices. It's important to note that penny stock prices can also jump up or down drastically due to news or company updates.
  • Know the company : To determine a good penny stock investment, it's essential to understand the company's financial ratings and overall performance. Also, look out for the company's management team and their track record with other organizations.
  • Research before you invest : Thorough research is vital before investing in any penny stock. Always read through its historical growth rate, income statement, balance sheet and cash flow statements before investing in the stock.
  • Diversify your portfolio : Diversification can be critical for penny stock investments. Investing a portion of your funds into stocks from different industries and companies can help reduce risk and increase potential profits from these stocks.
  • Shareholding patterns : It's always wise to check the shareholding pattern of any company before investing in it. If many promoters hold on to the stocks, you can deduce that they believe in their potential and prospects. Assessing the success of a company's promoter and non-institutional investors is key to ensuring its long-term growth. Knowing who these actors are can help us understand how quickly the firm may increase in value.
  • Have an exit strategy in place : Before buying penny stocks, ensure an exit strategy is in place. Also, it's essential to keep abreast of the current market trends and news to make timely decisions when required.

With these guidelines in mind, you'll be one step closer to choosing the best penny stock for your portfolio.

How can you trade or invest in penny stocks?

Penny stocks can be bought and sold in segments like any other stock. Here is how you can start investing in penny stocks in three simple steps:

 

Step 01 : Open an account by finding a broker who can serve your needs. Take into account the ease of transferring funds and fees. For example, some brokers offer a commission per share basis or flat rates for the first set of shares. And different for each additional share. It is not a good structure for penny stock traders. Instead, opt for a broker that provides a low-flat rate.

 

Step 02 : Determine what stocks to trade. For this, you can use screening tools provided by the OTC market, and here, you can easily filter your choices.

 

Step 03 : Get your financial journey started.

Concluding remarks:

If you’re tired of playing it safe with stocks, then you can try a slice from the penny stock pie! These highly volatile offerings can offer delicious returns, but their small size means you'd better buckle up for an unpredictable ride. It's like cooking in your kitchen - there could be rewards...or risks that even Gordon Ramsay couldn't stomach.

Share this article: 

FAQs

Can I open multiple demat accounts?

Answer Field

Yes, you can open multiple demat accounts but only under the below conditions:

  • You can open only one demat account per DP using the same PAN card.
  • You can open multiple demat accounts with different DPs using the same PAN card.

No results found

investment-card-icon

What is Trade & Carry?

A trader can enhance his/her potential in the stock market with the facility of carry and trade. Learn, what is carry and trade, how to use it and what are the benefits of it.

investment-card-icon

Share Market Timings in India

Understand share market timings in India. Learn the best times to trade in the dynamic Indian share market.

investment-card-icon

Share Market Timings | BSE & NSE, Opening & Closing | Bajaj Broking

Discover the Indian share market's schedule with our comprehensive guide on share market timings, helping investors align with trading hours for ideal strategies.

investment-card-icon

Stock Market Trading Holidays

Explore in-depth insights on Stock Market Trading Holidays in our Knowledge Centre. Stay informed with expert analysis, tips, and guidance.

investment-card-icon

Dividend Yield Calculator

Explore in-depth insights on Dividend Yield Calculator in our Knowledge Centre. Stay informed with expert analysis, tips, and guidance.

investment-card-icon

What are Penny Stocks

Explore in-depth insights on What are Penny Stocks? in our Knowledge Centre. Stay informed with expert analysis, tips, and guidance.

investment-card-icon

Difference Between Cash Flow And Fund Flow

Explore in-depth insights on Difference Between Cash Flow And Fund Flow in our Knowledge Centre. Stay informed with expert analysis, tips, and guidance.

investment-card-icon

Diversification in Investing

Explore in-depth insights on Diversification in Investing in our Knowledge Centre. Stay informed with expert analysis, tips, and guidance.

investment-card-icon

What are Equity Shares

Learn about equity shares and their significance. Dive into the basics of equity share investments in the Indian share market.

investment-card-icon

Zero Coupon Bond

Explore in-depth insights on Zero Coupon Bond in our Knowledge Centre. Stay informed with expert analysis, tips, and guidance.

Our Secure Trading Platforms

Level up your stock market experience: Download the Bajaj Broking Mobile App for effortless investing and trading

Bajaj Broking App Download

6.5 Lac+ Users

icon-with-text

4.1 App Rating

icon-with-text

4 Languages

icon-with-text

₹ 3500 Cr MTF Book

icon-with-text