What are penny stocks, and should you invest in them?

What are penny stocks, and should you invest in them?

Many traders have a diversified portfolio when it comes to trading stocks online. Some prefer to invest in a variety of companies and indices, and some buy stock derivatives such as Stock CFDs and Stock Options. With the need to spread out one’s investments to make sure one doesn’t put all their eggs in one basket, some investors also like to invest in and trade penny stocks.

In this article, we will look at what exactly these stocks are in detail. We will also look at what it is about penny stocks that appeals to traders, and what are some of the risks that traders may face. Finally, we will share a few tips on the ways you can minimise these risks when trading. If you are keen to trade stocks online, read on.

What are penny stocks?

Penny stocks are typically low-priced stocks that trade outside of major market exchanges, and they often have a small market capitalisation. These stocks are highly speculative and carry a higher degree of risk than stocks that trade on major exchanges, due to their relatively lower liquidity and high volatility. Penny stocks are often issued by new or small companies and are seen as a way for investors to get in on the ground floor of a potentially promising venture.

Examples of penny stocks

Examples of penny stocks include companies in various industries such as technology, biotechnology, mining, energy, and cannabis. Some well-known penny stocks include companies like Canopy Growth Corporation (CGC), Aurora Cannabis (ACB), Chesapeake Energy Corporation (CHK), and Eastman Kodak Company (KODK). However, it is important to note that investing in penny stocks can be risky, and investors should conduct thorough research before making any investment decisions.

What are the advantages of investing in penny stocks?

Despite their reputation, penny stocks can be attractive to investors looking to invest in high-growth potential companies at a low cost. These stocks are often issued by small, startup companies that are not yet established in the market. They may also be focused on emerging technologies, innovative products or services, or niche markets. Below, we explore some of these advantages in-depth.

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Low investment capital required

One of the biggest appeals of penny stocks is their low price. Low investment requirements mean that investors can potentially buy many shares with a relatively small investment. This can give investors the opportunity to see significant returns if the stock price rises.

High growth potential

Penny stocks often belong to smaller companies with high growth potential, such as start-ups or small to medium size companies on the rise. This means investors who get in early may potentially see their portfolio grow rapidly, as opposed to stocks from established companies that tend to be relatively stable. This can be an attractive investment opportunity for those willing to take on the risk.

High volatility

There is also the appeal that comes with the high volatility of penny stocks. Due to the large fluctuations in the market, there is a potential for large gains in either direction in a short period. This is great for short-term traders who want to take advantage of these rises and falls.

Diverse companies

Finally, penny stocks can also offer traders the ability to diversify their existing portfolio, as they exist across various industries. Most of them can be found in the technology, biotechnology, mining, and energy sector. There are also penny stocks to be found in the healthcare, finance, and retail industries. This makes it very easy for traders to invest across sectors and diversify their investments.

What are the risks of investing in penny stocks?

The low price of penny stocks can make them an appealing investment option for those with limited funds, but it’s important to note that they carry a high level of risk. Below, we will explore some of these risks in detail.

Low liquidity

Penny stocks often lack liquidity, which is their first risk. Low liquidity means traders can find it difficult to sell their shares quickly if the market takes a turn for the worse. This can result in significant losses. Low liquidity can also make it difficult for traders to enter the market in the first place.

Lack of transparency

Many penny stock companies do not have a long track record of financial success, and information about their operations and management can be difficult to obtain. In addition to this, these companies may not be required to provide the same level of financial reporting as larger companies, even when you own their shares.

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High volatility

While high volatility can be attractive for those with larger risk appetites, they can also prove to be a big risk. As penny stock prices can fluctuate wildly, it can be challenging to predict the stock’s future performance either in the short- or long-term.

How to minimise the risks of investing in penny stocks

The risks that come with penny stocks may be slightly higher than those that come with investing in traditional or blue-chip stocks. Nevertheless, if you are keen on trading them, there are preventative measures you can take to make sure you keep your risk to a minimum.

Do your research

Investors looking to invest in penny stocks should do their research thoroughly and approach with caution. It’s important to evaluate the company’s financial statements, management team, and competitive landscape before making any investment decisions. This can lower their susceptibility to fraud or other types of mismanagement or potential warning signs.

Set stop-loss orders

A stop-loss order is an instruction to your broker to sell your shares if the price drops to a certain level. This can help limit your losses if the stock takes a sudden turn for the worse. It can also help you keep your peace of mind when you are not monitoring the markets all the time.

Have an exit strategy before you enter the market

Penny stocks can be highly volatile, and it’s important to have a plan in place for when to sell. Usually, you should aim to have an exit strategy before you enter the market. This exit can be based on a certain price target, a particular event or news announcement, or simply a predetermined timeline.

Diversify your portfolio

Finally, you should always diversify your portfolio and make sure you are not only investing in penny stocks. You should also be looking at traditional or blue-chip stocks, or across financial markets, such as trading forex and commodities. This can help you mitigate the risk of any one stock tanking and ruining your portfolio.

So, should you invest in penny stocks?

The answer to this question depends entirely on your risk appetite, personal investment goals, and your preferences. Therefore, it is hard for anyone else to make the decision but you. However, it is worth saying that penny stocks do have the potential to offer high rewards for those willing to take on the risk.

Nevertheless, it’s important to do extensive research and due diligence before investing. Investors should be prepared to monitor their investments closely and be willing to accept the possibility of losing their entire investment. You should also never invest more than you can afford to lose. If you are in doubt, you should contact a financial professional or advisor.

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About the Author: Lisa Jack

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