Shares priced below ₹5, ₹8 or ₹10 often attract small investors in the stock market. The low price can create the perception that a large number of shares can be purchased with limited capital and that a sharp rise in the stock price could result in multiple-fold returns.
Penny stocks can also attract increased investor interest when they witness sudden price rises and repeated Upper Circuits. However, a low-priced stock is not necessarily cheap. Similarly, repeated Upper Circuits do not establish that a company's business is b or that its financial position is better. In penny stocks, there can be a significant gap between the share price and the actual value of the company. Understanding the risks is important before investing in such stocks.
Penny stocks often have lower trading volumes than larger stocks. With fewer buyers and sellers in the market, even limited buying or selling can have a significant impact on the share price. For example, if a stock is priced at ₹8 and buying suddenly increases, limited availability of shares and restricted selling can push the price up rapidly.
Such movements can appear particularly large in percentage terms. Conversely, when selling increases and buyers become fewer, the share price can also decline rapidly.
The stock market has a prescribed daily price band for each stock. When buying increases to the point that a stock reaches its predetermined upper limit, an Upper Circuit is triggered. Normal trading above that level is then not possible on the same day. In penny stocks, low free-float, limited selling and a sudden increase in demand can cause this situation to occur repeatedly.
This can increase FOMO, or Fear of Missing Out, among investors. Investors may start buying because they believe that failing to invest immediately could mean missing the next price rise. However, judging a company's quality solely on the basis of Upper Circuits is not appropriate. It is more important to understand whether the rise is supported by actual business reasons or is driven by demand and limited availability.
The risk in penny stocks can increase further when a stock begins hitting Lower Circuits repeatedly. In such a situation, a large number of investors may want to sell, but there may not be enough buyers. As a result, investors may continue to hold the shares without having a practical opportunity to sell them. A stock can sometimes remain locked in Lower Circuit for several consecutive trading sessions.
The price may be displayed on the screen, but executing a transaction at that price can be difficult. This represents the major risk associated with low Liquidity. When required, an investor may not be able to immediately convert the investment into cash.
Low-priced stocks can be quickly influenced by social media posts, online forums, messaging groups and unverified reports. Investors may suddenly begin buying after reports emerge about a major order, a new partnership, an acquisition or expansion by a company. However, not every report circulating in the market reflects the company's actual performance. A price rise triggered by a rumour can sometimes later turn into a sharp decline.
Investing in a stock solely on the basis of social media tips or claims made by others can therefore involve significant risk.
The share price alone cannot determine whether a stock is cheap or expensive. Assessing a company's valuation requires examining several indicators, including Market Capitalisation, Earnings, Debt, Cash Flow, Promoter Holding and Valuation. For example, a ₹5 stock is not necessarily cheaper than a ₹500 stock. The total number of shares issued by a company and the size of its business are also important factors.
