Penny stocks are stocks that are traded at very low prices. These stocks can be traded at around Rs 2, 3, 5 and probably under 10.
Investors tend to buy these stocks because they have a tendency to make money much faster then any other stocks. Let's give an example.
If you buy say for example a share of Infosys, it would take years to double from the current value of Rs 1950. But, for a penny stock bought at Rs 5, it could double your money and become Rs 10 in just a matter of days.
It's impossible for Infosys, Reliance, ITC or any other Sensex stock to double money in days. It's therefore the easiest way to make money in penny stocks. But, take a look at the pitfalls.
Most of the penny stocks rally on the basis of information, which at times could be misleading. What this results in is a temporary price rally. Now, the real problem is that if there is no significant improvement in the earnings of the company or the information you received is incorrect, you would probably get stuck with the stock.
After the euphoria has died down, you would have no buyers in the counter and your shares could be illiquid. This is of course a possibility and not that it happens in all cases. In stock markets, you cannot definitely say that a penny stock would not become a blue chip. They would be a dramatic statement to make.
All we are saying that the risk is high, as the company may lack the fundamentals.