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All You Need To Know About Penny Stocks

Stock market, according to some novice investors, is the easiest and quickest way to make money. The allure of chasing high growth stocks which can provide multiple times returns in a short period without much of hassle draws a lot of people to the stock markets. For such investors, small cap stocks are like a goldmine. With plenty of stock brokers in India offering online trading in a very convenient and user friendly manner, investors who are unsure about how to go about investing once they open up a trading account are easily drawn to these small cap stocks or penny stocks.

The reason most people seem to be drawn to investing in penny stocks is that share prices of such companies fluctuate wildly in very short periods of time, providing very high returns potentially. Penny stocks are those that trade at a very low price, have very low market capitalization and are mostly illiquid. Typically, stocks trading under Rs 10 on Indian stock exchanges are called as penny stocks.

While some of such small cap stocks can really provide excellent returns in a short time due to upbeat market conditions, savvy management and well thought out execution of business plans, there is a high risk involved in most of such investments. Plenty of small cap stocks suffer from lack of information about the company policies and management vision. The market penetration is very thin and a change in government policies or a sudden spurt in raw material prices can affect the performance of these types of penny stocks almost instantly

Liquidity can also be a headache in case of such stocks. Penny stocks tend to see large ask/bid spreads and are highly illiquid at times that can make it difficult to enter or exit a position. At times though, when a compelling growth story is associated with a small cap stock, investing at a right time can deliver good returns. Even while taking such investing decision, an investor has to maintain utmost caution and should ensure that the generic track record of the company is steady in terms of earnings and business growth over the years. Another thing to watch out for is debt. Please avoid companies with an excess amount of debt.

Further, it makes sense to avoid a company which is having too many subsidiaries. A high institutional shareholding is preferable.Investors have to bear in mind that in most of the cases, penny stocks are of companies that are not transparent in providing reliable information. The stock prices of such companies canbe manipulated by speculators, leading to wild swings in either direction without any clear reasoning to support it. If possible, investors can attend the companies' annual general meetings to get a further clarity about the nature of operations, management commentary and business outlook.


Despite the possibility of attractive gains, a rational investor with clear idea about his finances should avoid trading/investing in penny stocks. The risks associated with such kind of small cap stocks aretoo high compared tothe likely benefits in terms of heavy returns. Please keep in mind that market discounts everything and there must be compelling reasons why small cap stocks trade at such low prices. Investors are better off chasing companies with consistent earnings, superior set of products andstrong cash-flow growth. It makes sense to look at the management quality, business moats and scalability of operations. Most stock brokers in India provide investors with updates on such companies from time to time and an investor should focus on such quality stocks to enhance the performance of their portfolio.

Blog by –Mr. Ashish Ajmera

Also Read: - Five Effective Ideas For Long Term Wealth Creation
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