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What Are Penny Stocks?

Personal Finance

Penny stocks are the stocks in the share market that trade for under five dollars per share and have a low market capitalization. They are usually listed on a smaller exchange and are mostly liquid; hence, they are speculative and highly risky.

They belong to the category of low-priced and high-risk public companies. The potential for high yields is higher than that of a more traditional investment vehicle such as mutual funds or fixed deposits.

The most common use of penny stocks is in day trading, as it’s considered an easier time frame to work with than larger margin requirements and lower transaction fees. Penny stocks also have high volatility when compared to other equities due to their smaller price ranges. One of the most significant risks associated with penny stock trading is that it can be halted at any time due to their prices being manipulated to gain a quick profit.

It is important to understand that penny stocks are available for purchase for a wide variety of reasons and are therefore used as a way to attain different types of results. The hope is that the best penny stocks will be purchased through research and analysis, making the investment more valuable.

Features of Penny Stocks

It is easy to recognize penny stocks in the share market. Here are some features that make them easy to understand and trade:

  1. Limited Information About Their History: Relatively new companies usually issue penny stocks, so there is limited information available about the trading of these stocks. Often, these stocks don’t have a record of returns and losses. This lack of information makes them extremely risky. 
  2. Negligible Public Information: It’s not necessary for the companies issuing penny stocks to file reports with regulatory authorities. Also, professional analysts don’t cover them as well. That’s why you will not find much public information about these companies.  
  3. Low Cost: This is one feature we have been talking about since the beginning of the article. With its pricing, identifying a penny stock is extremely simple. They will be the most inexpensive shares in the stock market. 

Advantages of Penny Stocks:

Here are a few reasons why you must invest in penny stocks.

1. Low Investment Requirements:

The amount of money you’ll need to invest in penny stocks tends to be lower than investing in larger-cap stocks. So, if they deliver, you get a significant profit, but if they fail, you don’t lose much.

2. Higher Yields:

When looking at the industry averages for penny stocks, it is clear that they provide higher yield returns than other equities. Penny stocks also tend to provide high capital gains over the long term due to their higher yields and steady growth.

3. Easy-to-Understand:

Penny stocks are generally easy to understand due to their low price per share, which makes them more accessible to everyone. In the stock market, penny stocks do not need much formal analysis to make successful trades once you have some experience with them. But if you’re new to penny stock investing, don’t forget that there should be some research into your chosen industry before sliding into the share market to make a purchase decision. 

4. Funds Small Cap Companies:

Penny stocks are the perfect way to invest in small-cap companies. These companies are often seen as having heightened growth potential as they’re not as large as more traditional ones and hence provide great return opportunities. Although they usually don’t hold large amounts of cash, they can be invested in other stocks, which results in an overall increase in your profit.

Disadvantages of Penny Stocks:

1. Higher Risk:

The risks associated with penny stock trading are very high, and it’s important to be aware of the risks and understand the chances of success before you start investing. The most notable disadvantage to penny stocks is the increased risk in comparison to other equities.

Also, the downside to trading penny stocks is that there’s a higher risk of price manipulation, causing your shares to be halted. This is only sometimes the case, but it’s more common than in other markets. 

2. Low Liquidity:

The lower the liquidity of a stock, the harder it is to make a profitable trade with that stock. Penny stocks are often considered to have very low liquidity because there aren’t many shares outstanding compared to other equities. This means that the trade is smaller and more difficult to profit from.

To make profits, traders will often purchase high volumes of stocks to increase their capital gains. The lack of a large number of shares in the share market makes it easier for traders to manipulate prices through market orders if they’re aware of significant buy or sell orders; which means that low liquidity equals a higher risk level.

3. More Fraudulent:

The higher risk and lower liquidity can often result in greater opportunities for fraud. Although there are many successful penny stock investments, there is also a high amount of fraud and money manipulation involved. Traders need to be aware of this when researching penny stocks. However, there have been reports of penny stock trading being more profitable than emerging IPOs or less liquid over-the-counter stocks.

Wrapping Up

Penny stocks are a good way to make fast capital and can be easily bought by individuals or traded on margin with a brokerage account. However, they must first be researched and analyzed before being purchased. It is essential to understand that penny stocks can be manipulative due to their popularity and smaller market sizes.

When trading penny stocks, it’s essential to understand the risks associated with them. However, the stock market comes with many risks and rewards, and penny stocks are less risky with more rewards. You can always consult an institution like Piramal Finance for more information about penny stocks and other different forms of security and their risks.