Equity Research Tutorials
- Equity Research Fundamentals
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- Sell Side vs Buy Side
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- How does the Stock Market Work?
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- Dollar Cost Averaging
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- Small-Cap Stocks
- Large-Cap Stock
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- FAANG Stocks
- Penny Stock
- Sec Filings
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- 10K vs 10Q
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- Capital Gains vs Dividends
- Loss Aversion Bias
- Investment vs Speculation
What is Penny Stock/Shares?
Penny Stocks are the stocks which trade in the market at a very low price and having very low market capitalization. Mostly they are not liquid and it is possible that whenever the investor wants to sell his stock, he will not get any buyer for the same. These stocks usually are listed on smaller exchange and trade via OTC i.e., over the counter transactions although some of the penny stocks also trade on the large exchanges like new york stock exchange (NYSE).
Example of Penny Stock / Shares
Let us take an example of a penny stock / Shares.
There is a stock which is currently trading in the market at the price of $ 2. As the price of the share is very less, this will fall under the category of penny stock. Now Mr. X owns 60,000 penny stock at $ 2 each. Suddenly the price of the stock increased to $ 4 and gave a return of 100 % to Mr. X. This increase in the price of a stock from $ 2 to $ 4 gave Mr. X $ 120,000 in one single day. This earning is not possible when the large stocks are considered because, in the case of the large stock, large capital is required in order to buy such a high volume of shares.
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Advantages of Penny Stock
Some of the advantages are as follows:
#1 – Low Price per Share
The price per share of the penny stocks is very less which is the main advantage of the penny stocks as from the point of the investors there is no requirement of a large amount of capital in order to start the investment.
#2 – Increase in Investment Options
It is easy for the investors to buy the penny stocks because they are easily available for the general public to buy and since the prices are very low, the investors can buy many shares with less capital. This increase the options for the investors as he can at a time buy many of the penny stocks.
#3 – High Potential Rewards
They have the large potential of generating a higher profit to those people who can manage their investment property by conducting research and monitoring as there are huge stocks fluctuations in penny stocks.
Disadvantages of Penny Stock
Some of the disadvantages are as follows:
#1 – New Companies with No History
Most of the companies whose shares are being traded in the market as the penny stocks are the newly formed companies or start-ups. Chances are high that these companies have no or poor track record or even some might be approaching towards bankruptcy. This lack of information about the company makes it difficult for the investors to gain full knowledge about the company, determine the potential of stock and whether it is worth investing in that stock or not.
#2 – Lack of Liquidity
Mostly they are not liquid and it is possible that whenever the investor wants to sell his stock, he will not get any buyer for the same. To sell his stocks in case of requirement of funds he might have to lower the price of the share.
#3 – Hard to Make an Informed Decision
For generating the revenue out of the investments, it is required that one should have proper knowledge and information of the company and its stocks to take an informed decision. In case of the penny stocks, it is difficult to get the proper information as compared with the well-established companies where it is easy to get the information which is transparent too as they come from the credible sources. In case of the penny stocks even if the information is available it is highly probable that they do not come from the credible sources.
- There prevails huge volatility in the case of penny stocks, so if a person investing in these stocks does not pay attention properly to these stocks then he could end up being penniless. One should conduct proper research before investing and then monitoring it in the right way.
- It is good means of raising the funds in order to start and grow the business which is generally used by the small companies and the startups as it is one of quickest and effective means of raising the capital through the process is lengthy.
- Although sizable gain can be there when trading is done in the penny stocks as there is huge volatility in the market, at the same time, there prevails large risk as well of losing the significant investment amount even in short period.
- There is no guaranteed safeguard of the penny stocks, but sec recommends some warning signs to the investors which such as if there is any spam in company, there are large assets in company but at the same time revenue is small, there is unusual item in financial statement’s footnotes, any odd issues in the audit, etc. These warnings should be considered by investors before investors in penny stocks.
- Many skills are required in case one is trading in the penny shares and want to earn profits by overcoming risk. These skills include knowledge of the share market and patience. Also, the investor should invest a small amount in the beginning, get as much as possible information about stocks and market.
Thus it can be concluded that the penny stock refers to the stock of the small companies which trades typically for the amount per share less than $ 5. These stocks usually are listed on smaller exchange and trade via otc through otc bulletin board although some of the penny stocks also trade on the large exchanges like the stock exchange of new york. Although sizable gain can be there when trading is done in the penny stocks as there is huge volatility in the market, at the same time, there prevails large risk as well of losing the significant investment amount even in short period. so, along with large return there prevails large risk as well.
This has been a guide to what is Penny Stock and its definition. Here we discuss the example of penny stock along with advantages and disadvantages. You can learn more about equity research from the following articles –