A penny stock, or low grade securities sold trades at a very low price, usually below Rs 10, or is issued by a company whose market capitalization is less than Rs 100 crore. Penny stocks are generally investments in small companies, and present the high risk of loss, but also a higher return if the underlying business succeeds.
Sometimes referred to as “the slot machines of the stock market,” you may choose to supplement your investment with purchases of penny stocks, but should not rely on them as a primary investment due to their high risk. Few steps to take into consideration before investing and trading in penny stocks.
Limit Holdings and diversify
Cap losses by limiting your holdings in the stock to no more than 1% or 2% of overall portfolio. It also makes sense to diversify your penny stock portfolio, which shouldn’t exceed 5% to 10% of your overall portfolio, depending on one risk appetite.
Checking liquidity and trading volume.
Focus only on penny stocks with high volume. Even if one has made a successful investment in a penny stock, one need to sell to gain and book profit. Should have adequate liquidity and trading volumes in the stock so that you can trade it efficiently.
Generally stock should have at least 100000 shares a day. Otherwise it will nearly impossible to convert paper profit into an actual one.
Know when to sell.
It’s very rare for a penny stock to be a long-term buy-and-hold investment. The sector is built on short-term trades, so it’s as important to know when to sell as it is when to buy.
Allure of penny stocks is making 20% or 30% in a few days. If you make that kind of return with a penny stock, sell quickly.
Search for high-quality stocks.
Basically, some penny stock companies are worth more than others. Good prospects include ventures that are set up by experienced managers who have successfully exited a previous company.
Don’t trade large positions
One really need to be careful with position sizing and learned the hard way not to trade big. One should follow, not to trade more than 10% of the stock’s daily volume. In addition, limiting the position size so can get out of the stock faster.
Don’t fall in love with a stock
Every penny stock company wants you think it has an exciting story that will revolutionize the world. If you enter the penny stock arena, be cynical, do your own research, and diversify.
Pump & Dump scam.
Pump and dump is the most common scam witnessed in Penny Stocks and mostly in bull markets. In pump and dump, it involves artificially inflating the price of an own stock through misleading and false positive statements in order to increase the price from lower levels and to sell at higher levels.
This process is mainly experienced during strong bull market in small cap where even Fraud Company (Penny) or bad fundamental companies makes new highs every trading day. After hitting new highs, time comes where operator’s book profits and stocks continue to decline hitting lower circuits and it’s almost impossible to exit from the stock. Here are the few examples attached below shows Pump and Dump scams.
Review the company’s profitability.
The company income statement, or statement of earnings, shows how much money the company brought in as revenue during a period, and then how many expenses the business had to pay for associated with the revenue.
Look at whether or not the company had positive operating income – did it bring in more than it paid out? A company who is operating at a loss is less likely to grow and increase its value.
Check out the cash flow.
A company’s cash flow statement shows where it made and spent cash during the period. One can see from looking at a cash flow whether the company is spending the bulk of its cash on operating activities to run the business, investing activities to grow the business, or financing activities, the amounts the company pays to borrow money. These spending patterns can signal, whether the business is growing or if it is struggling to pay debts.
Penny stocks are very risky and demands lot of patience. Penny stocks can make lot of money. For example if one holds 10 penny stocks and among that 2-3 stocks goes in favor, an individual can be in good profits. However before investing and trading in penny stocks be sure of doing extensive research and understand where you are getting into.
This article is shared by Raja C V. Raja administers every aspect of Chartadvise.com, which provides share market courses in Mumbai. He takes care of a variety of technological, financial and administrative function to keep Chartadvise.com humming at peak efficiency all the time! Having a market experience of more than 8 years in advising on Equity, Derivative and Commodity he is able to handle client’s requests with ease. Possessing a very cool head, he is the best person to have on your side when the market gets into one of its usual erratic self.