Penny stocks are low-priced stocks offered by companies with small market capitalization i.e. below Rs. 5,000 Crore. The extremely low prices enable investors to purchase a substantial amount of shares for a relatively small amount of invested capital.
The gain of just a few rupees per share can render a significant returns percentage, of course, vice versa also because Penny Stocks are a highly speculative and risky segment of the market that can be considered as a hit or miss security. Therefore, it is better to know the rules to be followed when investing in Penny Stocks.
1. Avoid investing large amounts
Penny Stocks are issued by small-cap companies. These companies often have little or no financial history. It is a tough task to determine the penny stock’s performance. You will never come to know if the company is close to bankruptcy. Or maybe they are attracting a price higher than its cost and hence profitable. It is advisable not to invest too much in these stocks. Your investment portfolio should allow a maximum of 10% investment in Penny Stocks.
2. No liquidity
Since penny stocks lack a large pool of investors, traders can get stuck in a position for several days as they have to wait for enough supply/demand to enter/exit. Due to such illiquidity, traders may have to experience serious price fluctuations in between.
3. No diversification rule applicable
You cannot diversify your investments in a large number of penny stocks. You will not earn meaningful returns this way. There is no benefit to investing in 5000 penny stocks of 10-15 companies and monitor them. It is hard to monitor a portfolio of 10-15 low priced stocks. Instead, choose 2-3 stocks only that have reasonably high trading volumes. The monthly average trading volume of the stock will help you here.
4. Beware of scams
Most of you must have heard of pump-and-dump. It is a fraudulent practice where investors are encouraged to buy shares of a company to increase inflation. And then selling such shares while the price is high results in value inflation. Such fraudulent activities are presented with hype so that other investors are attracted to follow them.
Tread with caution while investing in Penny Stocks because small-cap companies tend to show major volatility in its stock prices. To proceed with the penny stocks too, you need a Demat account with a broker.
What is Demat Account?
Demat account is mandatory to hold your penny stocks or any other financial securities. Demat account eases the holding of various securities and keeps them secured against any theft or damage. Investors can track their stocks and investments through Demat virtually. Find a brokerage firm that meets your trading style and open a Demat account with the firm to start trading in penny stocks.
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