- Penny stock comes under the category of high risk, high return investment, usually trading below £1 and with low market capitalisation.
- Risk seeking investors and less experienced investors mostly seek to invest in a penny stock for high returns in short durations.
Everyone like the bargain purchase. In the stock market as well, the stock that quotes at low price attracts investors as these stocks can generate high returns. Penny stocks are the best example, which due to their low price offers immense opportunity. These are the stocks usually trading below £1 and have low market capitalisation.
Penny stock investors are, in general, risk-seeking investors who are willing to take greater risk in exchange for potentially high returns. These investors aim for high capital gain with the limited fund and penny stock provides a perfect opportunity. They are priced lower and come under the high risk, high return category of investment.
Why an investor invests in penny stocks?
- Investors with limited funds and new into the stock market generally look for penny stock that is low in price and could generate higher returns quickly. With limited research data available on a penny stock, investors mostly make buy/sell decisions based upon popular opinion on internet groups and news articles while investing in penny stocks.
- Investors who do research based investment in penny stocks, buy the company in its early growth stage and wish to hold the stock for a longer time horizon to capture a potential lot more share price upside than those who believe in investing once the company has grown into a giant.
As per market experts, a penny stock is most suitable to risk-seeking investors and usually recommend devoting less than 10% of your total stock holdings to penny stocks and diversifying the portfolio across different assets and sectors and investors whose priority is capital protection should stay away from penny stock investment.
Also Read: What are the best penny stocks for July?
The Risk associated with penny stock
- Penny stock companies are either newly established companies or possibly are in the bankruptcy stage. Newly formed companies are yet to prove themselves in the industry and often has less historical data to compare past performance. Hence investors have limited scope to do research and make a well-informed decision.
- Scammers use some penny stocks to pump the stock prices by promoting the penny stock company as the next big innovation company, and many investors fall for this artificial hype and purchase the stock and once the stock rises to a certain price level, shares of the company are dumped in the market and positive promotion is stopped. The share price decline causes considerable losses to later-stage investors. As penny stock has limited information available sometimes even the company’s insiders are also involved.
- Penny stocks do not have a superior price discovery mechanism, you can find a big difference between the bid and offer prices. Also, a penny stock is less frequently traded and finding a buyer/seller at the exact time of transaction could be difficult.