The Risks and Rewards of Penny Stock Trading

Read our Advertiser Disclosure.
Contributor, Benzinga
December 22, 2023

Penny stock trading can be volatile and risky but also rewarding if your trades make money. Stocks below $250 million in market capitalization are considered penny stocks, and each stock is often less than a $5 share price. Owning and trading penny stocks on a low-cost basis means that you could profit significantly if the stock price goes up. On the other hand, you could lose everything if the stock price goes down.

The best way to approach penny stock trading is with caution and a healthy dose of skepticism. Make sure you understand what you're getting into from the start and don't invest more than you can afford to lose.

What are Penny Stocks?

Penny stocks are stocks that trade at a relatively low price, usually under $5 per share. They are typically issued by small companies and are considered to be high-risk investments. Penny stocks often have low liquidity and are susceptible to volatile price fluctuations. While some investors may see penny stocks as an opportunity for quick profits, they also come with significant risks and are not suitable for all investors.

Risks Involved With Penny Stock Trading

Before investing your money, it's important to understand the potential risks of penny stocks and how to minimize them. Here are the risks associated with penny stock trading. 

Low Liquidity

When it comes to penny stock trading, a major risk is low stock liquidity. A lack of liquidity means that the stock has less trading activity and volume, so it can be difficult to buy or sell when you want to. Low trading volumes can be a problem if you need to get out of a trade quickly because you may not be able to find a buyer. While you are waiting for someone to take the other side of your trade on a stock exchange, the price of the stock may go against you.

Volatility

Penny stocks are generally much more volatile than the stocks of larger companies. Prices can fluctuate rapidly, and it is not uncommon for stocks to suddenly lose all of their value. For example, a stock might jump 10% in a single day only to fall by the same amount the next day. These price swings make it difficult for investors to predict when a stock will rise or fall.

Lack of Transparency and Information

When you buy a penny stock, you're typically buying a share of a company that is not required to disclose detailed financial information to the public. You don't know much about its financials, management or business model. All you have is a name and a stock ticker. The lack of information makes it difficult to determine the true value of a company. It’s possible to get involved in trading stock of an unproven or, worse case, fraudulent business.

Market Manipulation

The low trading volume in penny stocks opens the door for price manipulation and large price swings. If a larger buyer or seller comes in to try to move the price, it is much easier to change the market price when few buyers and sellers exist.

Rewards of Penny Stock Trading

There are a lot of misconceptions about penny stock trading. Some people think penny stocks are only for experienced traders, while others believe trading them is nothing more than a gamble. In reality, penny stock trading can be a way to make money if you are willing to put in the time and effort and take the risk. Here are some potential rewards of trading penny stocks.

High Returns

While penny stocks may be associated with high risk, they also offer the potential for high returns. For investors willing to take on a higher level of risk, penny stocks provide an opportunity to achieve greater gains than what may be possible with more mature, established companies.

When a company's stock price is only a few cents per share, if the share price changes by one cent, the percentage return can be quite significant. For example, a $0.10 stock would have to increase by $0.01 to earn a 10% return.

Because the fortunes of small and fast-growing companies can change very quickly, it’s possible that even a small investment can result in a significant return.

Low Cost

An example of penny stock rewards is that they have a relatively low cost, and you can start investing without having to commit a large amount of money. For example, let's say that you want to buy shares in Company XYZ. If each share is priced at $1, you would only need to invest $100 to get 100 shares. This lower cost barrier makes penny stocks an attractive option for many investors.

Company Access

Penny stocks are usually a type of stock that trades for less than $5 per share. Generally, you can trade the stocks of companies that have not met minimum regulatory requirements. Companies that have not reported financials yet may trade as penny stocks. You might be able to buy promising new companies or companies that have dropped significantly in value.

Who Should Invest in Penny Stocks?

If you're looking for a way to invest your money and see returns, penny stocks may be a new avenue to consider. Here are groups of people who should consider investing in penny stocks.

Experienced Penny Stock Traders

Experienced penny stock traders may have the knowledge and expertise to properly research penny stocks and make informed investment decisions. These traders typically better understand penny stock risks and how to avert them.

Short Sellers

Short selling is a type of trading that involves selling a security that you do not own and then buying it back at a lower price. This type of trading can be profitable if the price of the security falls as expected. Given the relatively high risk of penny stocks, short selling may be a viable strategy for those looking to profit from these types of securities. Investors should conduct thorough research before entering any trade.

Speculators

Penny stocks are notoriously volatile, and it is not unusual for them to lose all their value overnight. For these reasons, penny stocks are best suited for investors willing to take on a high degree of risk in pursuit of high rewards. Speculators are investors who thrive on risk. They often buy and sell penny stocks to make a quick profit. While this strategy can sometimes pay off, it is also risky.

Approach with Caution

Penny stock trading has risks and rewards. The risks include low liquidity, volatility, lack of transparency and potential market manipulation. However, for those willing to take the risk, penny stocks offer the potential for high returns and low-cost entry into the stock market. It is important to approach penny stock trading with caution, conduct thorough research and only invest what you can afford to lose. Successful trading requires knowledge, skill and risk management.

Compare Penny Stock Trading Brokers

If you're thinking of getting into penny stock trading, you need to be aware of the risks and rewards. Penny stocks provide the potential for a quick profit, but the downside is that many penny stocks are not proven companies.

To trade penny stocks, you’ll need a brokerage that allows you to trade them. Each brokerage platform has its own unique set of features and benefits, and fee structures or commissions will vary. Benzinga’s penny stock broker reviews help you make informed decisions about which platform is right for you.

Penny Stock Movers

Stock Movers

Gainers

Loser

Session: Apr 15, 2024 4:00PM EDT - Apr 16, 2024 3:59PM EDT

Frequently Asked Questions

Q

Is penny stock trading profitable?

A

Penny stock trading can be profitable if your stocks go in the direction you expect. You need to be careful with penny stocks and do your research before investing.

Q

What are the benefits of investing in penny stocks?

A

The benefits of investing in penny stocks are the potential for profitable returns and low required investment. Psychologically, investing in penny stocks seems attractive because the dollar amounts seem low. You can also access companies that are new although they may not be proven.

Q

Should I invest in penny stocks?

A

Penny stocks are risky investments because of their volatility and lack of financial stability. Investing in them can potentially result in high returns, but it is advised to diversify your portfolio and seek advice from a financial advisor.