Penny Stocks are usually those common stocks of small public companies that are traded at a cheaper price that have low market capitalization and are mostly less liquid. Penny Stocks widely suffer from several fundamental and other related problems.
The most important characteristic of penny stocks is that they are highly illiquid as they have very few shareholders. This is also the reason why they are not frequently traded in the stock market. Hence, their trading volume is also low when compared to other frequently traded stocks in the market. The demand and supply of penny stocks change rapidly due to the high volatility caused as a result of a lack of liquidity in the market. This makes it even riskier for traders and investors to trade in such penny stocks.
The lack of liquidity here makes it difficult for traders to sell a penny stock thus resulting in increased chances of potential losses. Considering this issue of liquidity, trading in penny stocks seems difficult as one might face the challenge of selling the penny stock once he owns it.
Also, due to insufficient information regarding most of the penny stocks, it becomes almost impossible to accurately price them. So those investing in penny stocks should be prepared to face loss on their whole investment in case anything wrong happens with the company.
While the penny stocks carry high risk, they also carry scope for potentially high returns/profits mainly because of the asymmetric information related to the company which probably leads to undervaluation of these penny stocks thus making them cheaply available in the market. Hence, small retail investors who don’t have heavy pockets may seem to invest in such penny stocks as penny stocks tend to be a tempting choice for small retail investors. Having said that, it is very crucial to invest in any penny stock after carrying out thorough research about the company and its financials. Following a techno-fundamental approach while researching a company seems to be a very useful strategy.
However, due to the high-risk attribute, we would advise small risk appetite traders and investors to avoid trading or investing in penny stocks as it may pose a great risk of suffering a potential loss. For those having a high-risk appetite, it may be wise to consider trading or investing in penny stocks only after conducting in-depth research about the company and its growth potential in the near future. Generally, most traders and investors avoid trading or investing in penny stocks due to their highly volatile nature.
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