5 points to consider before investing in Penny Stocks

Penny stocks are highly attractive to many investors. This is because they are cheap to buy and open the doors for many people who could not invest in standard and more expensive stocks. However, you can make a lot of mistakes if you're not careful.

Penny stocks lure a large section of investors. Their acquisition cost is cheap (often in low single digits) and the upside potential is almost limitless. A mere couple of rupees or, in some cases, a few paisa rise in the stock price would double or triple your initial capital. On the flip side, purists and market pundits look down upon investments in penny stocks. And they have valid reasons to be skeptical about penny investing.

Most penny stocks are little-known companies with a poor track record of financial performance. Their business plans cannot be trusted or bought at face value, either. These companies can easily go into oblivion without any trace. This makes penny stocks risky bets in any market situation. You may make millions or end up forfeiting your entire capital.

But optimists consider risk as the other side of return. Greater the risk, larger is the reward. The returns on penny stocks, however, depend on the extent of diversification. This segment has a high mortality rate and the only way to reduce stock-specific risk is to start with a larger portfolio.

However, you can make a lot of mistakes if you’re not careful. Consider following points while preparing your penny-portfolio :

1. Do your own research : The low price of penny stocks can make it more tempting to invest in one or more stocks without doing your research first. Research is vitally important because you need to know whether you are investing in a good or bad quality company. Penny stocks do not appear on the main stock exchange and the companies may well be less established as a result. Don’t risk investing in anything until you have done your homework on it first.
2. Credible source of information : Watch your sources of information too. There are lots of websites online that give out free tips and advice on which stocks to buy and which ones to sell. Always ask yourself why another person should recommend something to you for free. Trust your own instincts and knowledge more. This comes back to doing your own research once again – you can’t get out of this aspect of trading penny stocks if you really want to stand a chance of making a profit.
3. Not every penny stock can make you fortunes : Another mistake is to think that profiting from penny shares is easy. You might just pick a good company that is about to enjoy massive success – but it doesn’t happen every day by any standard. Never assume that trading in penny shares will make you your fortune – you could lose a lot of cash through thinking it is easy.
4. Build a large enough portfolio : Diversify your risk and build a large portfolio of carefully selected penny stocks. Although the portfolio will have some losers, whose value might have become zero, the few stocks that eventually turn into multi baggers will significantly offset such losses and give superior returns.
5. Know your risk appetite : Always remember that penny shares are risky propositions. You can just as easily lose every penny you invest as you can make money. So before you buy into any particular company, make sure you are happy with kissing goodbye to that money should something disastrous happen. Save for a while to build up a pot you don’t mind losing if need be – but don’t bet the money you can not afford to loose on trading penny stocks. Ignoring your risk appetite could be disastrous.

You should also make sure you don’t rely on a broker to help you pick your stocks. Your own decisions, instincts and research take precedence over everything else, so make sure you remember this.