What are penny stocks?

Penny stocks are shares of companies that may not be widely known or followed by traditional investors. Despite this, the stocks can offer investors an alternative way to participate in the markets, though high risks are involved.

These stocks can be appealing to those who prefer not to invest in established companies and are willing to accept higher risks for potentially greater rewards.

While it’s true that companies like S&P 500 constituent Monster Beverage and Fortune 500 newcomer Sirius XM were once penny stocks.^,, there are limited success stories with penny stocks, and the majority of them fail. The high failure rate indicates that there’s a good chance many investors will lose their money. That’s why investing in this type of stock isn’t for everyone.

In this article, we’ll dive into what penny stocks are, how to buy and trade penny stocks and how to think about the risks involved.

Penny stocks are often associated with companies that trade for $5 or lower per share, according to the Corporate Finance Institute. Some investors may only consider something a penny stock if it trades for less than $1, though.

Penny stocks – often referred to as micro-cap stocks – typically have a market capitalization of less than $300 million. They often trade on OTC marketplaces, where stocks that aren’t listed on the New York Stock Exchange (NYSE), the Nasdaq or other major exchanges are traded. These stocks can be relatively illiquid, making it more difficult to quickly buy and sell shares. With fewer trading opportunities, penny stocks tend to be more volatile and susceptible to big price swings.

A significant risk associated with penny stocks is their lack of a proven track record compared to companies listed on major exchanges. Penny stock companies don’t have to meet the same regulatory reporting requirements and generally aren’t analyzed by traditional Wall Street firms, so it can be difficult to access reliable information. The limited data means these investments are highly speculative.

Penny stocks can be volatile. Big fluctuations in the stock price can lead to big gains and big losses. This is why penny stocks can be favored by some speculative investors who like the low prices, enabling them to buy large quantities of shares in the hope they may realize quick gains.

Given the volatility and risk associated with penny stocks, if investors choose to engage in this type of investing, they should do so with their eyes wide open.

Penny stock benefits

Penny stock enthusiasts point to several benefits of this type of investment, including the following:

Penny stock risks

Penny stocks on a per-share basis may be cheap, but the high failure rate means many investors lose their money. Here are some of the risks investors need to consider:

Blue-chip stocks are stocks of well-established companies that typically have strong financials. Let’s examine how blue chips stack up against penny stocks, which may be considered much riskier investments.

Buying and trading penny stocks

To buy penny stocks, you need to open a brokerage account with a firm that offers OTC trading. Be aware of the fees that brokerages may charge for investing in penny stocks. Some brokers may charge more to purchase stocks below a certain price or if you make more than a specified number of trades. Watch out for per-share fees, as these can eat away at your potential returns when you buy a lot of stocks.

Once you open an account, you need to fund it. After that, you can use your broker’s platform or online tools to search for penny stocks. When you have found the penny stock you want to purchase, you can then place an order with your brokerage. If you’re interested in this type of investment, it's a good idea to start small, and only allocate a portion of your investment portfolio to this that you can afford to lose.

A general rule of thumb when investing is to take a balanced approach, ensuring that risky assets make up a small part of a well-diversified portfolio. It's also important to understand the risk associated with penny stocks. If you go in thinking you’ll make a fortune or fund your future retirement, you are likely setting yourself up for disappointment.

Are penny stocks worth it?

Penny stocks can sometimes provide early access to growth stocks. For most investors, though, the risks far outweigh the potential rewards. Penny stocks rarely make retail investors rich.

For those that are interested in penny stocks because of the low capital requirement for entry – these are shares of stock, after all, that trade under $5 a share – you may also want to consider fractional share investing, which allows investors to buy slices of shares, including NYSE and Nasdaq stocks. Buying small slices of expensive shares makes even expensive stocks accessible.

While there are certainly risks involved, penny stocks can appeal to certain investors, particularly day and swing traders who may be more comfortable with the risks. Investors hunting for hidden gems will need to do a lot of research and due diligence with whatever information is available. Finding successful penny stocks is rare and requires careful consideration.

The bottom line

Penny stocks are not for the faint-hearted and are not ideal for investors who can’t tolerate or afford risk. They are speculative investments in small companies, often volatile by nature and with little in the way of a proven track record. While they may feel attractive because of their low cost of entry and potential to be the next big thing, investors considering trading in penny stocks should be fully aware of the risks and, if proceeding, to invest only a small portion of their portfolio.

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