Retail investors often in search of quick gains end up buying penny stocks. The reason is not difficult to understand. Such micro-cap stocks tend to move rapidly. This can lead to quick profits. However the opposite is also true. When the markets fall, these stocks tend to crash. Therefore, such stocks rarely witness any action when market sentiment is poor. They only start their up-move when there is widespread optimism in the markets.
This certainly seems to be the case these days. Retail investors are flocking to stocks of smaller companies again. Market sentiment has definitely improved over the last few months. Expectations of a new government, post the elections, is the main reason for the same. With the markets touching new life highs almost every week, retail investors have been returning to the market. What is unfortunate is that their interest has not been directed towards stable companies with strong fundamentals. As per an article in the Economic Times, retail investors have increased their holding in small companies with questionable fundamentals.
The buying interest seems to be coming from a new set of investors who have entered the market for the first time during a bullish phase. Also there are many people who had missed out on the big up move in sectors like software last year. It appears that greed has taken over in the stock markets. Retail investors are buying shares in firms without paying heed to the fundamentals.
This is extremely risky behavior, we believe. While stocks of small companies certainly offer an opportunity for large gains, they are inherently risky investments. Time and again investors have burnt their fingers in such stocks. The opportunity to make quick gains cannot override the need for a detailed analysis of such companies. Retail investors would do well to avoid small companies with poor fundamentals and stick to stable firms which can offer better long term returns.