What are Penny Stocks?

If you’ve been looking at the different categories of stocks available in the Indian financial markets, chances are, you may have heard of penny stocks. Penny stocks are the stocks that trade at extremely low market prices, often below ₹10. The market capitalization of these stocks is also quite small, owing to their low market prices. However, while risky, penny stocks are a hit among investors due to their low market price. In this article, we will help you understand what penny stocks are, how to identify them and how to trade in penny stocks.

Understanding Penny Stocks in India

Penny stocks in India are traded on both the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Since the prices of these stocks are very low, they do not require huge amounts of capital to be bought. However, penny stocks are typically highly speculative in nature, and they are not generally highly liquid. This increases the risk associated with such low-price stocks. The trading volume is relatively low for penny stocks, and they carry large bid-ask spreads. They are also prone to sudden bouts of volatility, which is how speculating traders typically stand to gain from such stocks.

Benefits of Investing in Penny Stocks

• Low entry point increases the affordability for beginners
• High volatility is good for active investors who are looking for short-term gains
• Long-term investing in fundamentally strong penny stocks help investors get higher returns for less capital

Characteristics of Penny Stocks

Penny stocks have some defining characteristics that set them apart from other categories of stocks. These are also features that you should be mindful of before trading in such low-price stocks.

• Low Price

  This is perhaps the most defining feature of penny stocks. Their prices typically tend to hover in the range of ₹10 to ₹20, although a few stocks in this category may have prices below or above this range.

• Low Trading Volume

  Penny stocks typically tend to have low trading volumes because of their low liquidity. The difference between their bid and ask prices tends to be large, and often, it may be tough to exit any holdings you may have in these stocks.

• Unpredictable Performance

  It can be tough to predict how the prices of penny stocks will react to typical market movements. Even when they do change, the prices of these stocks may only increase or decrease by a few paise over several trading days, leading to only marginal returns, if any.

• Small Market Capitalisation

  Owing to their low stock prices, penny stocks typically tend to have small market capitalisations. This is because the total value of the shares traded will continue to remain low, even if the number of shares traded is high.

• Speculative Nature

  Since the prices of these stocks are unpredictable, trades involving penny stocks are typically more speculative in nature. They are not suitable for long-term growth or value investing in most cases.

How to spot a Penny stock with potential?

If you’re interested in long-term value investing, chances are, you may not want to include penny stocks in your portfolio. This is because most penny stocks may not have the potential to increase in value over time. However, there are some low-price stocks that may become winning scrips. How do you go about identifying which penny stocks are the winners from the plethora of options available to you? The following tips can help:

• Study the fundamentals

  The best way to identify the potential of a company is by studying its fundamentals. Fundamental analysis, in particular, can be very useful. Look at key ratios like the price-to-earnings ratio, debt-equity ratio, dividend payout ratio and other such metrics.

• Check the company’s valuation

  Valuation can tell you crucial details about the company. If a stock is overvalued, it may not be a suitable investment because of potential price drops in the future. On the other hand, an undervalued penny stock may hold some potential for price rise over the long term.

• Beware of the dilution Effect

  Stock dilution occurs when a company issues more shares, thus reducing the ownership percentage of existing shareholders. If the penny stock you hold suffers from the dilution effect, the overall value of your holdings could further reduce.

How to trade Penny stocks?

Trading penny stocks is similar to trading stocks in other categories. Here’s a brief overview of what you need to do.

• Open a demat and trading account

  The first step to trade in penny stocks is to open a demat and trading account. For the best overall experience and assistance at every step of the way, you can choose a trusted stockbroker like m.Stock where you pay zero brokerage charges for life across products like intraday, delivery, F&O, currency etc.

• Identify penny stocks with potential

  Next, identify penny stocks of companies that have a lot of potential for future growth. This is particularly crucial if you are planning to hold the stocks over the long term. On the other hand, if you merely want to trade in these stocks over the short-term, you must look for volatile stocks.

• Determine the percentage of your portfolio necessary for penny stocks

  Since penny stocks come with a high level of risk, it’s best to limit your exposure to such stocks as per your risk profile. The lower your risk tolerance, the lower the percentage of your penny stock investments should be.

• Have an exit strategy in place

  For traders keen on benefiting from short-term stock price movements, an exit strategy is crucial. If this sounds like your plan, you need to have an exit option in place before you buy a low-price stock.

• Make your purchase

  Once you have all the above boxes checked off, you can proceed to buy the penny stocks of your choice.

List of Penny stocks

Here is a list of some of the top penny stocks in the Indian financial market, as of 2023.

Risks and Considerations of Investing in Penny Stocks

• Low Liquidity

  Due to low investor interest, penny stocks usually face difficulty while buying or selling.

• Highly volatile

  Penny stocks are unpredictable and risky because they are prone to volatility in the market that may lead to losses as well gains.

• Low Transparency

  The penny stocks often are not compliant with exchange regulations and therefore lack transparency.

Pros and Cons of Penny Stocks

Investing in penny stocks have both pros and cons.

• The pros are as follows:

  Although penny stocks can be extremely changeable, they can also yield huge returns in a short time that make them appealing to investors. This means they can grow very fast for big profits even if the investments were small. In most cases, penny stock traders start with small amounts of money. For instance, an investor may only be able to buy a few shares of a blue-chip company with Rs 10,000 but could acquire thousands of penny stock shares. Not all penny stocks are volatile; however, some move very rapidly changing their prices dramatically within days instead of years.

• And the cons are as follows:

  Because they frequently trade in low volumes penny stocks are illiquid making it difficult for those who own them to sell. Such actions ultimately give an inaccurate picture of the company by causing temporary increases in its stock price. That is why dishonest investors refer to it as “pump and dump” when engaging in such behavior within an environment which is characterized by very little liquidity which means that you cannot get your money back easily because you cannot easily exchange these shares with money--unless someone else wants them and agrees on the price.