The risks and rewards of trading penny stocks

As penny stocks require such a low minimum outlay, many new or inexperienced traders fall into the trap of thinking they are simple and can offer a worthwhile turnaround. This is the opposite of the truth in fact, as the market can be extremely volatile and have a higher potential for losses when not utilised in the right way. Stocks that can be traded for under £5 could be an indicator of either growth potential or a company that’s about to go bust, so understanding the intricacies of this niche is imperative.

These types of stocks are typically traded on either supporting platforms (keep in mind that not many have penny stocks in their inventories). The platform you choose for trading penny stocks is likely to have its own rules and regulations, so be sure to do some research before selecting the one you’d like to utilise. Take any fees they place on trading into account, as well as your preferences, for the most worthwhile experience.

Essentially, any stocks that are traded at much lower prices than traditional ones are considered penny stocks. In the UK for instance, these are defined as any shares that fall anywhere under £1 up to £5 (this may be different for other countries, currencies and securities markets, however). In general, they are purchased and traded less often as there are typically fewer buyers and sellers.

Here are some examples of the penny stocks you could trade:

This method of trading is considered to be speculative, but the right selections could spell profits for little initial outlay. On the same note, losses can occur due to low liquidity and the fact that there are fewer shareholders overall.

One of the biggest draws of these stocks is that traders can diversify their portfolios without spending too much. They are cheap with a decent return potential and can even improve risk tolerance for traders who want to push their endeavours a little further.

When you do find a reputable stock to trade with, volatility can be an issue. Prices drop fast and can be highly unpredictable, so losses can often be more than you’d expect. The real value of penny stocks is hard to determine, as many are created by companies that want to make a quick profit, so long-term viability isn’t likely.

Risks can be minimised by selecting companies with proven track records and doing extensive research before trading - and sites like the FCA can be helpful when understanding the risks involved.

When a trader decides to use leveraging, they will be borrowing money from a third party (typically a broker) to take up more worthwhile trading positions. While these types of stocks are inherently cheap, leveraged trading can help you to take up more positions and diversify trading avenues.

While there are many risks involved with penny shares (more so than with other options), there is still some potential when it comes to profit margins. Trading will only be a worthwhile choice for those with extensive knowledge, a keen eye for scams and those looking for more short-term endeavours. For additional insight, take a look at trading penny stocks in the uk before making any financial moves. Finally, ensure to mitigate any potential risks by carrying out thorough research into companies and trading strategies. Consider placing trades on a demo platform first and making use of features such as stop losses.

Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.

Read more: Advanced CFD trading strategies