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Summary
- Penny stocks are securities that trade for less than a dollar.
- A lack of credible history and information, and low liquidity make penny stocks risky, especially for the newbies.
- It would help if you first learned the rules of investing in penny stocks since it is very different from investing in regular equities.
Penny stocks are generally defined as the shares of a company trading for less than a dollar. These companies have low market capitalisation. Penny stocks have historically been popular among retail investors due to a perception that these can help retail investors to get rich quickly. Penny stocks tend to surprise with significant upside, especially during a bull run.
There are several stories if penny stocks becoming multi-baggers over a very short span. However, it is not easy to spot the right penny stock. It takes proper research and patience to pick the undiscovered gem from the many available options. In addition, penny stocks are generally considered highly speculative due to their lack of liquidity, wide bid-ask spreads or price quotes, and small company sizes. In simple words, investors could lose a sizable amount or entire investment.
It would be best if you first learned the rules of investing in penny stocks. Investing in penny stocks is different from investing in regular equities. Even though these rules may not ensure 100% success with penny stocks, they will improve your chances to hit upon the right stock.
READ MORE: Looking for small-cap stocks? Here are three shares for 2021
Source: © Herrbullermann | Megapixl.com
Invest nominal amount
The low-priced shares offer a relatively easier way of building money. It is easier to make 100% profit in a stock priced at AU$1 than AU$40. But there are also chances of quickly losing 100%. Generally, a fundamentally strong stock could bounce back from a steep fall, there is less probability with a penny stock of doing such. According to experts, investors should not invest more than 3% to 5% of their corpus in penny stocks.
Be patient and research for the undiscovered gem
As already mentioned earlier, choosing the right penny stock means doing your due diligence and looking at the company's financials. But lack of credible information and low liquidity makes the entire exercise very challenging. It would help if you worked hard to spot a stock that is ‘truly’ undervalued. You may be required to research 30-40 companies before you find something worthwhile. It is easier said than done.
READ MORE: Trajan Group’s shares surge 40% since IPO; can it sustain gains?
Trading volume
It is easier buying penny stocks than selling them. These stocks are highly illiquid, and a significant part of the shareholding lies with the promoters who are not willing to be buyers. Thus, you would not find many takers for penny stocks. Even if your stock has doubled in value, it becomes difficult to realise the gains at times.
According to experts, you must track the trading volume very closely for last six months to 1 year to check if it is consistently high. Any irregular spike in volume could be due to manipulation and not high liquidity.
Source: ©Miflippo | Megapixl.com
Strict stop-loss targets
Investors should be vigilant while investing in penny stocks. It would be best if you always worked with strict stop-loss targets. Unlike regular stocks, the temptation to invest in penny stocks when their prices corrected sharply can be dangerous. It may not be a regular market correction, and the stock price may have fallen due to serious business problems or manipulation. There are chances that stock exchanges may even de-list the company, so you cannot even trade in that stock. In such a case, you may have to forget your investment.
READ MORE: Top five renewable energy stocks on ASX
Meanwhile, investors are always expected to choose their stocks carefully if they plan to venture into the risky category of penny stocks. Either you can conduct detailed research at your end or approach your financial planner before going ahead with the buy. The level of probability is higher of scam and bankruptcy of the underlying firm. It would be best if you did not blindly accept all the recommendations about penny stocks.
