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Benefits and risks of investing in penny stocks 

equity market
07 Mar 20246 mins readBy MOFSL

Introduction

As the name suggests, penny stocks refer to stocks traded for low prices, usually below Rs.10. Considered to be high-risk and high-reward investments, penny stocks are often associated with small and low capitalisation companies or those facing financial challenges. These stocks may be affordable due to their low share price. However, understanding the risks associated with penny stocks is essential to make an informed decision. Keep reading the article to learn the advantages, risks and tips of investing in penny stocks.

Advantages of investing in penny stocks

Now that you know what penny stocks are, below is the list of advantages of investing in them:

  • Low entry costs

The main advantage of penny stocks is their low prices. If you are low on capital and cannot afford high-priced shares, penny stocks can be a good investment option since you don't have to put in a lot of money to buy them. 

  • High return potential

Investing in penny stocks can be beneficial due to their high return potential. Since the prices of these stocks are low, even a marginal rise in their price can lead to significant gains. 

Read More: Penny Stock in India 2024

  • Chance for early investment

Penny stocks allow you to invest in small and promising companies. Investing in the early phase of these companies offers you the opportunity to become a part of their growth ladder and the potential to earn handsome returns over time. 

  • Profits from volatility

The volatility of penny stocks can provide you with profit-making opportunities from short-term price fluctuations. 

Risks of investing in penny stocks

Despite the potential advantages, you should consider the following risks related to penny stocks: 

  • Lack of transparency

Learning about the financial health and overall performance of companies issuing penny stocks is difficult. Due to less information about these stocks than those of larger companies, you may not be able to evaluate their risk and return potential effectively.  

  • Unpredictable prices 

It is challenging to predict penny stock prices due to a lack of transparency, limited trading, and the potential for scams. You may make a lot of overnight gains but also incur losses in even less time. 

  • Lack of liquidity

Another drawback of penny stocks is the need for more liquidity. Due to high risk and volatility, buyers are wary of buying penny stocks. The wide bid-ask spread and few buyers can make executing trades at your desired prices difficult. As a result, your capital may get locked in loss-making companies. 

  • Potential for scams

Penny stocks are vulnerable to fraudulent activities such as pump-and-dump schemes. Such schemes involve the manipulation of stock prices by unscrupulous parties to sell them at profits, leaving you with huge losses.

Things to consider before investing in penny stocks

While investing in penny stocks is risky, keeping in mind the following things can help you avoid losses:

  • Do your research 

Penny stocks are usually issued by small and new companies that enjoy a different popularity than large publicly traded companies. Hence, it is essential to do thorough research if you don’t want your hard-earned money getting locked in a loss-making company. 

  • Make limited investment

You may find penny stocks attractive and buy more due to their low prices. However, these stocks have low liquidity and high volatility. So, start small to limit your losses if the prices of penny stocks drop rapidly. Invest only according to your risk appetite since the low trading volumes may not allow you to pull out money on time. 

  • Make a short-term investment

Penny stocks investment should be short-term. You may make overnight gains but lose your money the very next moment. Some penny stocks can also become worthless. So, try capitalising on rapid price movements through strategic buying and selling. 

Conclusion 

Penny stocks may have the potential for significant gains. However, these stocks are risky due to high volatility, low trading volumes, and scam potential. The need for more sufficient information about companies issuing penny stocks is also a major drawback. Ensure you don’t fall for rumours and invest hastily in penny stocks. Go the extra mile to research before investing. 

 

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Disclaimer: The stocks, companies, or financial instruments mentioned in this blog are for informational purposes only and should not be considered as investment recommendations. It is advised to consult with your financial advisor before making any investment decisions. Investment in securities markets are subject to market risks, read all the related documents carefully before investing. Investors are strongly encouraged to carefully read the risk disclosure documents prior to participating in market-related investments or trading activities. Due to the volatile nature of financial markets, no guarantees can be made regarding investment returns. Motilal Oswal Financial Services Ltd. does not offer any assured returns on market-linked securities. Please note that past performance of stocks or indices is not indicative of future results.
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