Have you lost your money investing in a penny stock?
You would have received several messages from random numbers stating, “Buy 5000 shares of Xyz Company at INR 2. The price will become INR 10 in a week. Do not miss this exciting opportunity to multiply your money in a week”
If you have received such a message on your phone, be wary. You may become a part of the scam without meaning to. Read on to know more about penny stocks. It can help you safeguard against such scams.
One of the most common mistakes that most newbie, inexperienced investors make is investing in such penny stocks.
What Are Penny Stocks?
Penny stocks are public companies trading at low prices (typically less than INR 10 in India and less than 1 dollar in the US).
Doesn’t everyone like cheap stuff and discounts? That is the case with Penny stocks too. Young investors feel why to spend over INR 3k to buy just one stock of TCS when you can buy 1000 shares of some penny stock trading at INR 3 per share. The mindset is to acquire a lot and get rich quickly.
Why Do People Invest In Penny Stocks?
Many young investors are fascinated by the movies like Wolf of Wall Street and other films glamorizing the world of stock markets and finance, which is not always an accurate picture. They often fall prey to the quick-rich-scheme traps. Most people wonder –well, how long it will take a stock price as low as INR 5 per share to be INR 10. The share price fluctuation in this company is enormous.
You would generally see these sudden price increases so huge that it may be hard to hold on to these stocks. In no time, a stock would jump from INR 5 to INR 30, and you would just be surprised watching that, wanting to participate in such huge wild profitable moves. The naïve newbie investor would think, “Wow! If I had put INR 20,000 in that, I would have been able to turn it into more than a lakh in no time!”
That’s the trap!! A stock price would catch your attention only when most of the price has moved when you enter. More often than not, you end up wiping your entire capital as the stock would then nosedive into deep reds in the blink of an eye.
What Are The Key Risks Of Investing In Penny Stocks?
Unproven business performance record: Penny stock companies are largely infamous companies with minimal profitability and revenue growth. These companies do not have a proven history of financial performance. Stock price reflects the actual business fundamentals of the company. If there is no business, the stock price will not show you the results. These Penny stocks are usually disreputable companies and may have limited regulatory requirements and reporting needs. Because of the lack of market information, it becomes difficult to research them before investing.
Pump and dump schemes: Most of the promoters of these companies themselves manage and manipulate the prices of these penny stocks. These tricksters typically target naïve retail investors by promoting and pushing marketing techniques advising them to buy these penny stocks. In the initial few days, you would see that the price will go up, and you feel a bit of FOMO that you missed out on the profits. That’s pumping of the share price. Once you enter the stock, like many other retail investors, these promoters and their allies would dump the stock and take the exit with a huge chunk of profits. The retail investors who fell prey to such schemes may end up losing their entire capital.
High price volatility: Penny stocks are highly volatile investments. These stocks typically trade in circuits – either upper circuit or lower circuit. A circuit is a scenario where there are either no buyers or no sellers, and the price has moved only in one direction. Such volatile moves are not healthy for an investor as these stocks lack liquidity. You consider a scenario where the penny stock nosedives and starts its streak of lower circuits – you will not be able to sell your stock and take the exit.
Lack of trading volumes: As discussed in the earlier point, the buyer may not find a counterparty seller or vice versa because of a lack of trading volumes. Although you may buy the stock for INR 1, which is now worth INR 2, you may not be able to sell unless another investor is willing to buy it from you. You may be making unrealized profits on paper, but you may not be able to book your profits.
Things You Should Understand About Investing In Stock Markets
- Calculate percentage gains: Stock price increase from INR 1 to INR 1.5 is the same as INR 100 to INR 150 – both imply a 50 percent increase in price. So by no means the penny stock has a more straightforward pathway to grow faster.
- 50 Percent of Something Is Better Than 100 Percent of Nothing
It is better to own fractional shares of quality, high-priced stocks than to own more shares of a penny stock, which is not worth it. Let’s continue with the same example mentioned above. It is better to own one share of TCS for ~INR 3k than to buy 1000 shares of some penny stock trading at INR 3 per share, worth zero.
Well, a thorough read of the article will tell you investing in penny stocks is not recommended. You may not only lose your capital, but also waste time and effort that can be used to research fundamentally strong stocks that can help you create wealth.
Read more: About Research and Ranking.