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What are Penny Stocks?

11 Mins 17 Mar 2023 0 COMMENT

Equity stocks are a unit of a company’s ownership which are offered to investors to raise capital. Investing in stocks is gaining momentum as it provides the opportunity to earn competitive, inflation-beating returns over the long term. Equity investments are highly flexible, allowing investors to buy and sell stocks at any time.

There are different types of shares and stocks depending upon their nature and the voting rights they offer. Some stocks are often termed penny stocks which are a type of stock with a very lower market price. Let us dive into the details and understand the concept of penny stocks.

Penny Stocks Overview

The word penny in the literal sense means a cent. This gives way to the hint that penny stocks are those with a very low price in the stock market. In India, penny stocks are generally considered to be those stocks that are traded below the price of Rs 50. The market capitalization of these companies is very low.

Market capitalization is a metric to evaluate a company’s total worth. It is the total market value of a company’s outstanding shares. Based on market capitalization, companies can be classified into three main categories – small-cap, mid-cap, and large-cap.

Companies with a market capitalization of below Rs 5,000 crore come under small-cap, those with market cap of Rs 5,000 to Rs 20,000 crore are termed mid-cap, and those with market cap equal to or above Rs 20,000 crore are large-cap companies.

What are the benefits of trading in penny stocks?

  • Potential for higher returns

Its ability to earn incredible returns and sometimes turn into a multibagger is drawing several traders to trade in penny stocks. These stocks are mostly issued by companies in a very low or micro capitalization segment. They possess tremendous growth potential and the ability to deliver returns higher than various other asset classes and, within equities, even higher than large-cap stocks. However, given their ability to generate great returns, they involve a higher degree of risk. Hence, you must observe caution while trading.

  • Small scale investment

The prices of penny stocks are very low. This lets investors invest in the stock market with even a small amount of capital. They make a perfect pick to begin and learn trading hands-on. Furthermore, you can buy a good volume of stocks with small capital. For instance, even if you have only Rs 1,000 to trade for the day, check out the penny stocks list and let’s say you pick a stock that’s priced at Rs 5. Given this, you will be able to buy 200 stocks.

  • Fundraising for small companies

Penny stocks are a good way for small companies to raise capital from the public. These small companies can utilise the capital raised to improve their current offering, hire better talent, and execute various expansion plans. This will help them race towards attaining a higher market capitalisation and grow their value.

What are the various risks associated with penny stocks to be mindful of?

  • Unpredictable pricing 

Though penny stocks are capable of earning attractive returns, there is a possibility that things could swing the other way as well, given their unpredictable pricing. The stock prices, being low, are vulnerable to market manipulation and can see a steep fall that can erode investors’ wealth.

  • Illiquid

Penny stocks usually have low liquidity in the market. This means traders can find it difficult to find buyers for these stocks. The issuers of these stocks are very small and unpopular companies in which only a handful of traders trade.

  • Lack of information

Given the fact that penny stock issuing companies are of small scale and relatively newer, the information available in the market about them is very limited. These stocks are also usually avoided by analysts and researchers.

What you should keep in mind when trading in penny stocks?

Following are some quick pointers to keep in mind when trading in penny stocks:

  • Be thorough with your research before investing in any stock. Read and carefully examine any information available about the company’s financials. Also, gather information about the stock, the company’s current standing and its market potential. Always make trade decisions based on facts.
  • You must only rely on a registered stockbroking firm to trade. A trusted stockbroker will guide you to invest in the right stocks and safeguard your market position. They provide you with research reports from expert analysts that will help you make sound investment decisions.
  • Be mindful of your risk appetite at all times. Invest with the money that you can afford to lose. Do not let the bait of higher returns make you gamble your hard-earned money.
  • Cases of fraud in trading penny stocks are also very frequent. One such type of fraud is the ‘Pump and Dump’. Initially, scammers heavily purchase a penny stock causing its price to rise significantly. Given the hype, several traders purchase these stocks, leading to a sharp rally in prices. Once large quantities are bought from the market and the prices are inflated, the scammers immediately sell all their stock holdings and liquidate their position in these stocks. This causes a severe and sudden drop in prices leaving other unknown investors with huge losses due to the steep fall in value.

Bottom line

If you are well aware of penny stocks meaning and their potential, consider exploring them. Invest a small amount of funds in these stocks to grasp the returns they can earn for you first-hand. Continue to have the guard of caution up at all times. Set a stop loss order and square off your position the minute the associated risk begins to charge up.

ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.