Share Market Myth : Penny Stocks Can Make You Marvellous Rich

MarketSmith India has been highlighting some investing myths that need to be debunked in our webinars and learning articles.

These include the idea of buying a stock with its price on the way down so that your average cost goes lower and the notion that you can always make money by buying low, selling high.

Today, the myth that a growth investor should never fall for is the false promise of riches from penny shares.

You have probably received at least one email that read something like: ‘Invest now in X share, While you can still get it for INR 5, the stock looks set to Explode … Small Fortunes could be made by those who get in now!!!’

The idea of making big returns on what seems like a sure bet can be tempting. And people sometimes do get lucky buying the so-called penny stocks.

But, the purchase of such stocks carries with it an unusual amount of risk. For this reason, MarketSmith India focuses on high-quality, more expensive stocks that are priced at least at INR 20 a share and have a 50-day average trading volume of at least INR 1 crore.

Though the potential of making good returns is high with penny shares, the risk of losing it all is even higher. There are high chances of price manipulation as few investors hold majority stakes in the company due to its low market cap.

The penny stocks are extra-risky because they’re volatile; a handful of investors trading even a small block of shares can send its prices swinging wildly. Institutional investors tend to avoid such stocks because it is hard to build and exit substantial positions when only a few shares are traded.

Big funds have crores of rupees to invest in the market. So, they naturally prefer more liquid stocks and build positions over time. This lends an element of stability and predictability to a stock’s price movement.

When picking stocks, preference should be given to companies with strong business growth stories, and at a price, they are trading. The growth and evolution of a company’s business build the value of the stock. The price of the stock may garner temporary demand for a stock, but it cannot sustain returns over a long period of time.

Understanding stock markets, employing strict trading rules, and persistent learning will help grow investments and not just low-priced stocks.

Note that the average price of stocks in the Ind 47, or our Model Portfolio, is high. Most have their buy points that are in the range of INR 100 or higher, and in many cases, much higher.

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Disclaimer: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. It is for educational purposes only.

MarketSmith India is an investment advisory product based on William O’Neil’s Can Slim method with model portfolio, pattern recognition, idea lists powered by institutional quality data