Penny stocks is the most risky equity in the entire market. Small companies and startups issue their equity so that they can raise some additional capital for their business. Such shares are low valued and are known as Penny stocks. Also there are stocks which had high valuation and due to some degradation in value they suffer a heavy loss. These results in high value erosion and the stock prices get below 10 Rs or in the nearer range. Such stocks are also termed as penny stocks.
To summarize penny stocks have low valuation and are available in bulk in the open. Also they are having high risk due to two factors. Either they are startups or not well established businesses so they raise capital for their needs or they are high loss companies and have suffered high value erosion which makes them vulnerable to invest into. The reason for their vulnerability is that they can go out of business and their stock prices may take a dive to becoming zero.
Penny stocks by startups are created like any regular company is done with the help of IPO. The company has to get registered with SEBI and after approval and the registration process the IPO gets the [permission to get listed on the stock exchanges.
Price Fluctuations : High Risk and High Return
Penny stocks have great volatility in terms of their volume. The reason being that the value of any penny stock is very less and people could afford more quantity of the same in comparison to less quantity of high priced shares. The risk associated with penny stocks is very high. The reason is very simple: New startup or high loss making companies are prone to get shut down at any point of time. This results in zero valuation of the holdings. Hence the risk included is very high.
But as per the saying higher the risk higher the reward and penny stocks are a true example of the same. The reason is the volume in which penny stocks are traded and the price fluctuations based on the same.
Lets understand this by a recent example of stock Suzlon Energy. This was a high loss making company some years back and hence its value degraded and it came to nearly 2 Rs. This caused a great erosion for the investors. Contrary to that traders bought huge shares in the same and waited since then for the up trend. In the COVID situation after the March crisis the stock made a great recovery and touched nearly 7.5 Rs. This means that the stock witnessed growth of almost 300%. Hence if you have bought 100000 shares at 2 Rs. it would have given the return of Rs. 400000 approximately. Hence with investment of mere Rs. 2 Lac you get a return (profit) of Rs. 4 Lac.
Information Regarding Penny Stocks
General public has very little information about penny stocks. The reason is they dont take such risks with savings and hence focus on the blue chip stocks and their constant dividend only. Hence in penny stocks the movements are majorly caused by the promoters who hold large volume of the stock. To find a good penny stock is a very difficult task. People spread rumors about various stocks and to take an informed decision based on such information is very risky and upto some extent a foolish move. One has to get the entire information on these corporates and analyse the balance sheet. This gives information on various strategies that the company is going to follow. This enables a person to make informed decisions on the future growth of the company. The only shortcoming to these stocks is that very little information is available for them hence it becomes difficult to find accurate information for the same.
Pros
- Penny stocks are a mode of availing funding for the startups.
- It provides access to a large marketplace. The reason is the IPO enables the companies to gain the attention of the public.
- Lower price in the stocks enables a person to get more quantity of the stock at minimal investment.
- The growth possible is unlimited and the price appreciation is more likely for them.
- The risk is limited to the amount zero and return is unlimited.
Cons
- They have few buyers based on their reputation which is either of a loss making company or of an established company.
- Lack of information available about the company’s history and financial.
- They have high probability of fraud as the companies are driven by the promoters on a large scale.
- Bankruptcy is a very common phenomenon in such companies.
- Such companies do not provide dividends to their shareholders on a major scale.
Company Information
Though there is no long term history traceable for such companies it is possible to know about the valuation or the company’s situation. The person can refer the NSE or BSE website and refer to the recent legal actions against the company or the suspensions of licenses or any other fraudulent actions pertaining to the company.
Nowadays the online discount brokers have special features for providing company specific information. A person can analyze and research the company based on the information provided on the company’s profile. The discount brokers also enable clients to know about the financials of the company and the vital past details of the company. The best discount broker Zerodha has detailed information available for every stock. They also provide Nudge features for the companies so that the customer gets alerted before trading in those companies.
Buy Circuit and Sell Circuit
Penny stocks visit a very frequent circuit occurrence. One such example is Parle. The company frequently goes into circuit movements and has a fixed interval for its price movements. The promoters drive the stock prices to one direction and they offload shares or buy shares and take advantage of the price fluctuations to make money. It is not legal though people create shell companies sometimes and cheat the public with such price actions. One can notice such circuits in most of the penny stocks and they occur at frequent time periods.
Is Trading in Penny Stocks Safe or Not ?
If you look it is safe to trade in such companies as they are listed with the exchanges. The exchanges do perform a background check on such companies so that the general public is not cheated from them. Yet the risk of fraud opening is high in such companies based on their vulnerability and bankruptcy chances.
Trading is safe if you look from a security point of view but from a view point of return or profit gaining it is unsafe and has 100% risk associated with it.
Fraud and Penny Stocks
These companies are very much prone to notify a fraud as the companies are less trustworthy and are on the edge of bankruptcy. They have lack of liquidity and the circuit movements may not make it possible for the investors to sell or buy the shares when required. The low liquidity is a sign that traders may be easily open to manipulation of such shares. The penny stocks are purchased on low levels and released on the ceiling level. This makes such stocks a game for the traders. Here traders sell on high prices and buy at low prices and make the investors stagger in these price ranges.
