How do penny stocks work? – What I Wish Everyone Knew About Penny Stocks

Wednesday, 22 September 2021

By Amit Rawat

It’s very likely that if you have been into trading you must have heard instances of people earning big bucks from penny stocks! You might yourself be tempted to invest in these. Let us tell you everything we know so you can make an informed decision:

Understanding Penny Stocks

Definition: Normally by penny stock, we understand a stock that trades on the bourses at sub-one rupee price. But according to the National Stock Exchange(NSE) and the Bombay Stock Exchange (BSE), the stocks trading below INR 10 are all penny stocks and belong to the T2T (trade-to-trade) category. They have a market capitalization (number of shares outstanding times present by penny price of the share) lower than ₹100crores.

 

Risk-Return Tradeoff: These are high-risk stocks and obviously, you would want to invest in it if the return is high or at least expected to be high, or else why would you take the pain. There is no specific logic, at least not always, as to why most of their prices will rally generating a very high return. There is also a high risk of the exact opposite happening. There’s a high risk-return trade-off.

So, How do Penny Stocks work?

These stocks are the favorite of the manipulators. Why? Simple. The low price of the stocks makes manipulation easy and often without drawing much attention from the stock market regulators.

Example: A stock is trading at ₹2 it is easy for manipulators to drive it to ₹3 in a week or fortnight or even a month without giving the regulators a cause to be concerned. Think in terms of percentage. The gain is 50% – in a very very short span of time.

That said, while Penny stocks can generate such abnormally high returns they can also wipe out your investment.

Remember Jupiter Bioscience or Pyramid Saimira? If not, google it!

Guidelines when selecting Penny Stocks

  1. Make sure they sell real products or services such as Mannapuram Finance and have been present in the market for quite some time. (> 5 years)
  2. Take a look at the promotor’s holding. They are the first ones to run away from a sinking ship. For Jupitor Bioscience, promotor holding had been consistently decreasing every quarter before the stock vanished from the exchange.
  3. Try to dig into why these stocks are moving up. If you invest in the growth story, chances are you will not lose money. Take the example of Shiva Cement. Shiva cement started its northward journey a few days before the news of JSW Cement picking up stakes in it went public. The stock rallied from around ₹5.50 to over ₹23.50 within a span of 1 year. The return – a whopping 327% growth, as can be seen from the BSE graph 

Bottom line, not all penny stocks will be a multi-bagger neither will all wipe out your investment. While the above guidelines do not guarantee success, they give you some basic tips on how to pick penny stocks. But remember, investment in penny stocks is not for the weak-hearted. You must be prepared for any consequences.

 


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