Penny Stocks: The high-risk, high-reward Investment
How to choose penny stocks that are worth your money.
In this article, we will discuss Penny Stocks: what they are, why they are so risky, and how to choose the right ones if you decide to invest in them.
Penny Stocks: The Riskiest and Most Rewarding Investment?
Penny stocks are shares of listed companies with low share prices. They are often considered to be the riskiest type of investment, but they also offer the potential for the highest returns.
Penny stocks are also more volatile than other types of stocks. This means that their prices can fluctuate wildly, and you could lose a lot of money if you invest in them.
Should You Invest in Penny Stocks?
Whether you invest in penny stocks depends entirely on your risk appetite in the stock market. Penny stocks are the most volatile and most illiquid of all the stocks in the market. Thus, they present many challenges to an investor that are absent in other stock categories.
These stocks are notorious for delivering multibagger returns in a few months only to come crashing down and give up all the gains within the next few weeks. Due to their illiquid nature, it's very difficult to build a sizeable position in penny stocks. This is the reason why fund managers mostly avoid them.
Their low trading volumes also make them vulnerable to market operators who buy these stocks with the sole intention to drive up the price.
When gullible retail investors follow them into the stock, they dump their shares. Thus, the operators book handsome profits and leave the retail investors with huge losses. On the other hand, penny stocks have the potential to deliver the biggest profits compared to all other stocks in the market.
Well-chosen fundamentally strong penny stocks have the potential to deliver profits greater than 1,000 per cent within 1-3 years. This is almost impossible in the case of large caps. This is the main reason for their popularity.
Thus, in the stock market, penny stocks belong to the category of, 'highest possible risk for the highest potential return'. This is the reality you must accept when investing in penny stocks.
How Much Should You Invest in Penny Stocks?
Penny stocks are inherently riskier than blue chips or midcaps. They present a huge growth potential. It is not unusual for a good penny stock to turn a multi-bagger in a matter of months. But on the flip side, there is a high risk attached. It's common to see penny stocks plunge 80-90 per cent when things turn sour.
That is why penny stocks are not suitable for those having a low-risk profile. Even if you have a high-risk profile, we believe not more than 5 per cent of one's stock portfolio be invested in penny stocks.
This is the first part of our Penny stock series. Part 2 on the topic will be published soon.