Penny Stocks: Penny Invest, Pound Return!

Penny Stocks: Penny Invest, Pound Return!

If you are a trader or an investor, you would have eventually persuaded yourself to buy a stock which is quoting at a really low price say Rs.6 or may be Rs.8. The judgement to purchase these stocks quoted in single digits in all likelihood would not be a level-headed one, but instead an impulsive or emotional one. The run-of-the-mill manner of thinking would be something like: where else can I buy a tonne of shares for not much capital outlay or how much lower can the price go from here? And if these lotto tickets actually take off, it can make a difference between a buying a Porsche or a Maruti 800 for your next car!

Many of the greatest companies started out very small, with their stocks valued in single digits. In other words, they started out as what the investment world calls "penny stocks or micro cap." As those businesses grew in size, the stock price also grew and their shareholders were rewarded with a great fortunes.

One stock comes to mind when we talk about wealth creation is Lupin. Lupin was once a "penny stock", as in the year 2001 it was available somewhere around Rs.6.10-7 and it made a high of Rs.2129 in the year 2015. There are many such stories where a penny stock turned out to be mega wealth generator and did wonders to the portfolio of investors who held it patiently. And it is this potential for making money that explains the growing popularity of penny stocks.

DEFINITION OF PENNY STOCK: 

There is no universally accepted definition of the term 'penny stock'. However, low price per share is the most common and simplest criterion for identifying penny stocks. Many people apply the tag of penny stock to any stock which is trading below Rs.10 and having low market capitalisation.

WHY INVESTORS ARE LURED TOWARDS PENNY STOCKS?

Quick Fortune: One of the main reasons an individual gets attracted to penny stock investing is to make a quick fortune. They would have a small capital, let's say Rs.25,000, which they wish to turn into few lakhs in double quick time so that they can buy a vacation for their family and pay their expenses.

Early entry in next big company in the making: Investors are drawn to penny stocks because they are fascinated by the idea of investing in a tiny company in its early stages which they expect would become next Lupin or Eicher Motor.

Cost Price: One of the most critical reasons an individual is attracted to this universe of stocks is that they do not cost much and an individual can buy substantial quantity of these stocks with a reasonable sum. Many small investors feel that instead of buying 50 shares of a blue-chip company like Infosys, which would cost approx. Rs.50,000 they would prefer to buy about 5,000 quantity of a stock which might be trading around Rs.9.

No risk of downside: Many investors feel that penny stocks cannot fall lower as these stocks are trading at rock bottom level, hence there is no risk of downside.

Rags to riches: Penny stocks which turned multibaggers since November 2014.

There are about 11 stocks which have not just doubled or trebled, but gained over 1,000 per cent since November 2014 to November 2017 (Prices considered up to November 24, 2017).

Among the list of penny stocks which have gained the most is a manufacturer of plywood and allied products Uniply Industries, which saw its share price jump more than 4,400 per cent in the time frame of just three years. Another stock which delivered a gain of over 4,000 per cent is Fiberweb (India). It is important to have the requisite knowledge and the right temperament and expectations while making investment in penny stocks.

PENNY STOCK INVESTING MAY BE SUITABLE FOR AN INVESTOR HAVING THE FOLLOWING ATTRIBUTES:

Prepared to do the required home work: While investing in penny stocks, it is important for an investor to do proper homework, because every company will not be a next Lupin or HDFC Bank. Hence, you need to choose the select few penny stocks out of the large universe, so proper home work is required. It is like digging a gold mine to find gold.

Has the right temperament: Penny stock investing is inherently risky. No wonder, it is not recommended for those who want to play it safe. If you are going to lose sleep over 20 per cent price swings, such stocks may not be appropriate for you. Hence, while investing in penny stock, one needs to have patience and should not be disturbed by short term turbulence.

Has realistic expectations: One needs to have realistic expectations as every stock will not be a multi-bagger.

Has time to monitor stock continuously: As penny stocks are known to make explosive moves, one needs to monitor these stocks continuously. If these stocks are performing good you hold them, while if they disappoint and are continuously giving pain to your portfolio, get rid of them.

WHAT SHOULD ONE DO AT CURRENT JUNCTURE? INVESTING APPROACH IS MORE APPROPRIATE IN PENNY STOCKS:

During the bull phase, many penny stocks see a rapid move and traders likely to play actively for short term gains in these kinds of stocks. However, majority of us have found out to our chagrin that we had picked up stocks that inevitably went on to deliver multibagger returns. However we simply did not have the patience, persistence and the temperament to stick with them for a sufficiently long enough time. At a point when the elements of a good investment are unfolding, one simply needs to check occasionally if the initial thesis or investment rationale still holds true or is showing signs of improvement.

Hence, when it comes to penny stock, trading may fetch decent returns in the short term, yet one should take a look at penny stock as a wealth creator instead of cashing out with returns of 10 per cent or 15 per cent at the initial stage. As the objective of buying a penny stock is to find out next big company at the early stage.

Investing is the process of buying and holding a stock for the long term. Be prepared to grab these stocks till the market finds the hidden value in them and when the market discovers the value, the prices will rise many times over. Investing is a more appropriate approach for majority of those getting into penny stocks.

Trading generally involves looking for a short-term gain. Trading in penny stocks has certain hazards associated with it, such as higher spreads, less liquidity or circuit filters. Hence, it is better to invest in penny stocks.

THE STOCK MARKET HAS BEEN IN A BULL PHASE, WHAT SHOULD BE THE RIGHT APPROACH TO INVEST IN THESE PENNY STOCKS:

The way you invest can be as vital and sometimes considerably more important than where you invest. Following are best strategies which will help shield yourself from the drawback dangers and, at the same time, improve the probability of achieving consistent profitability.

1 Scale In and Scale Out: Too frequently, investors, particularly the novice ones, believe that they have to purchase or sell their shares at one go as there is an element of missing out the next big stock in the financial term it is known as "FOMO" Fear of Missing Out. So, if an investor wants to buy 3,000 shares, he will buy all 3,000 shares in one shot. As an investor in penny stock, during the bullish phase follow the approach of scale-in and scale-out of positions in penny stocks, which simply means buying and selling in tranches, rather than in a single trade.

2. Don't' put good money after a ‘bad stock': Jesse Livermore said in the book Reminiscences of a Stock Operator by Edwin Lefevre, "I must buy on a rising scale. I don't buy long stocks on a scale down, I buy on a scale up". Whether it is a bull phase or bear phase, over and over again, investors average their position when the stock has seen a quick fall. Nonetheless, this approach isolates them from the lot of successful investors who don't average down, however, they prefer to average penny stocks, one should be smart like a pro-investor he/she should average stocks only when stocks start to move higher after your initial purchase, it might be an indication that this penny stock is starting to find the right path. Arthur Huprich also known as Art Huprich of Raymond James has quoted "Don't average trading losses, meaning don't put "good" money after "bad". Adding to a losing position will lead to ruin."

3.Position sizing: Position sizing answers the question, ‘How big should I make my position for a stock?'. Set a predefined criterion for position sizing and every time an opportunity arises, invest as per the predetermined percentage of your portfolio.

4.Catch the impulse move: Significant ascents or descents in the price of penny stock happens over a short time. As quoted by Author A Wiley Brand in the book ‘Penny stocks for Dummies', generally 80 per cent of any penny stock's increases or decreases happen over 20 per cent of the trading days. By doing a little research, you can find out key corporate events which trigger an impulsive move. By playing trading impulse, you don't have to hold the investment for a very long time, which limits your risk exposure while opening yourself up to the potential of strong short-term price moves.

5.Look for value, not price: Valuation is a key factor while making an investment and low price does not mean that the valuation of the company is decent. Investing in penny stocks should not be viewed as buying a lotto ticket.

PROFIT-TAKING AN IMPORTANT ASPECT OF INVESTING IN PENNY STOCKS: 

In the current market scenario where many stocks have reached to their 52-week high or trading near life time high levels or stocks where we have seen rapid rise, , the very next dilemma for an investor is when to book profits. Following are the key indicators for taking your profits home after a merry ride: 1. When trading volume and delivery volumes decline: In the book ‘Penny stock for Dummies', the author has highlighted that when shares trade at a much higher price with a marked drop in trading volume and delivery, the penny stock may be about to take a tumble. When the buzz goes away, the share price often fails to maintain its lofty new level.

2. Bulk/intense selling: When a penny stock goes up dramatically in price over a short-medium time frame, a number of investors get itchy to book out their profit. When this happens, the medium term investors who have taken positions exit the stock, and if this selling is not absorbed, it leads to an intense correction in the stock.

3.When investment thesis gets diluted:One should book out profits when the investment thesis of owing the stock gets weak.

STOCKS THAT LEFT THE BULL MARKET IN THE DUST: KNOW WHEN TO GET RID OF THE LAGGARD:

While investing in these micro-cap stocks or hot penny stocks, you can learn a lot from judo. Nobody wants to sell an investment in a loss. Nonetheless, it's a confirmation that you committed an error. But if you accept a loss and set your ego aside, you can make a difference, both financially and mentally, to invest the next time. Following are some of the reasons to sell shares at a loss, which includes:

1. Technical analysis suggests a trend change: Technical patterns are effective tools which help an individual to forecast the likelihood of going lower; so when your indicators and patterns forecasts a fall in price, exiting the stock may help you escape from further downside and extending your loss.

2. Sharp sell-off with huge volumes: If a stock price falls with substantial volume, it suggests that many investors are getting out, which is a negative sign.

3. When a positive news flow has no impact on the stock: There are number of events which could trigger positive movement in a stock. However, regardless of the positive news flow, if the stock neglects to hold on to gains or does not show much impact on the price movement, this could be an indication that an upmove is used for offloading shares or market participants are not much excited about the event.

THE FINAL WRAP-UP: 

We all have heard the story about the ‘Goose that laid golden eggs'. The moral of the story was ‘Greed leads to huge loss'. The same moral goes for the penny stocks: One should not be lured into buying small denomination stocks in the hope of making a quick fortune. One should exercise caution while investing in these high-risk investments and should not allocate more than 8-10% of the total equity portfolio. Additionally, one should avoid averaging these stocks when the price moves substantially lower because this can result in loss of opportunity as the present market is offering good enough opportunities in different set of stocks. One should also understand the fact that not every penny stock is the next Lupin or an Eicher Motors, hence, it is important to track your investments and take timely decisions, whether it is related to profit booking or making a wise decision by exiting with minor loss.