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5 points to consider before investing in Penny Stocks

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.

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Manish Misra
Manish is an Internet Professional and is currently employed with India's leading internet portal. He has versatile experience spanning across internet, e-business and retail financial services domains.

He has authored several analytical articles on personal finance in The Times of India and The Economic Times. Being a finance geek and having been involved with internet since the early days of the medium, he was a great help and source of guidance while formulating personalmoney.in. You can know more about Manish at ManishMisra.com

Disclaimer : Manish has agreed to write in his personal capacity. Views, opinions expressed in his articles are his own and do not necessarily reflect the views of his employer.

http://www.personalmoney.in

10 thoughts on “5 points to consider before investing in Penny Stocks

  1. Hi,
    I wish to invest in penny stocks like Cals refinery etc, for at most five years. Do you think penny stocks can become multi baggers in just 5 years or my funds will be locked for many more years.

  2. Hi Sunny,

    As described above Penny stocks are a high risk high return category of stocks. It makes more sense if you invest small amount of money in a large number of carefully selected penny stocks for better returns minimizing the risk. Investing in one/two stocks involves huge risk, your investment can become multibagger in few months or you may have to write-off your investment completely. Since trading in these stocks happens mainly for speculative purpose and you might not get out of the stock when you want to if it is in the downtrend as there might be no buyers at all for the counter.

    Cals Refinery for instance had a 52 weeks high of 1.08 and is currently trading at its 52 weeks low of 0.42. If you feel this stock has sound business model and the management is committed you can start taking position in Cals in small chunks. Avoid investing a large amount in these stocks in one go.

    Hope this helps you in your investment decision.

  3. According to me, though one listens to others. We all know that experience is the best teacher. So initially one can try virtual trading through various free websites and when he/she is sure about the performance then can enter into actual trading.

  4. I like that you put doing your own research as the first point – there cannot be enough emphasys on this. You cannot just ask other traders for tip and how with the flow. You have to put in the time to understand the fundamentals.

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