The pros and cons of trading penny stocks

When you decide to trade in penny stocks, you are likely to come across a wealth of conflicting information regarding their viability as profit-making assets. On one side of the community, many traders will tout huge profits and on the other, many will report significant losses and undesirable factors that may turn you away. The reality is that trading in any kind of stock will often depend on you and how you undertake your endeavours – and having the right knowledge before putting your money on the line is the smartest thing you can do.

A brief intro to penny stocks and how to trade them

Penny stocks are defined as shares that are traded on the market for less than £1. As these are typically offered by small, publicly-traded companies and start-ups, they are often synonymous with low liquidity and high volatility. Price movements can be hard to predict, but there is potential for both high gains and significant losses.

The key to trading penny stocks is to use them as a means of diversifying your portfolio as opposed to using them as your main source of income. Trading volumes tend to be low and when paired with volatility and low liquidity, there is good reason to be cautious with the funds you dedicate to these endeavours.

Penny stock trading pros

Low costs

One of the biggest aspects to draw traders to penny stocks is the fact that they are so cheap to buy. This often leads newer traders to enter the market with little outlay, alongside more skilled investors who want to add more avenues to their overall trading experience without breaking the bank. When you have a set amount of cash to trade with (or leftover from your other efforts) it can sometimes make sense to prioritise volume over cost.

High returns

As the primary companies offering penny stocks are either new or small in size, there is the potential for significant growth, which could mean high returns if they take off. Of course, not all businesses prove to be successful, but there are instances where they could go on to be the next big thing – and you could be there to reap the rewards.

There are companies trading for pennies that are already relatively well established in terms of a great workforce and management, solid financial positioning, growing market popularity, rising ratios and even those with creative products or services that could potentially revolutionise their industry, so with the right research, you could find a hidden gem or two.

High-speed trading

Some penny stocks can make big price moves in a matter of days and when this is the case, you won’t have to wait around to find out if you’re making a profit or a loss. Going hand in hand with the point above, sometimes, companies can reach overnight success, and the profits you can make could have the potential to exceed your expectations.

Penny stocks trading cons

Unpredictable pricing

There are a lot of aspects to penny trading that are simply going to make pricing unpredictable. There is often limited information out there, trading can be infrequent at best and then there’s the fact that little regulation can mean a high level of fraudulent activity. Even the most attractive penny stocks aren’t safe from extreme volatility and high market capitalisation, so there isn’t ever a ‘safe bet’ when trading.

Low-quality stocks

There are plenty of penny stocks out there from low-quality companies with poor finances, unattractive balance sheets and operations that suffer large losses. Sometimes industries are over-saturated or are simply falling out of favour and this can lead to a host of less-than-desirable options for traders to take advantage of.

The market is prone to scams

With all of the pros and cons in mind, it’s not hard to see where scammers see the potential to profit from unsavoury tactics. One of the main areas hit is price manipulation and due to the lack of information in the niche, it can be difficult to spot the trades to avoid.

Risk management

Ensure to protect yourself from large losses by making use of demo accounts and stop losses. Furthermore, it’s essential to research the market and industry of the asset you’re looking to trade.

Should you trade penny stocks?

All trading endeavours come with both pros and cons, so it’s always going to be worthwhile to do your own research on penny stocks and make a decision based on your needs (you can learn more here). There is profit potential with penny stock trading, as well as the ability to lose a lot of money, so be sure to perform some due diligence before putting your capital on the line.