What are penny stocks?

What are penny stocks?

Penny stocks are common shares of smaller companies traded for less than £1 in the UK and below $5 in the US. The market cap on penny stock companies is below £100 million in the UK, and below $300 million in the US.

The general sentiment behind investors buying penny shares is that you bet on a small company that’ll grow over time. This adds an added element of risk, but some consider it to also have high rewards.

See the best performing UK penny shares

Are penny shares more volatile?

Penny shares are often more volatile than other stocks, because they belong to companies that are either very small or newly listed.

This means that they’re sensitive to market news and developments, and there’s low liquidity. On the other hand, this also means there could be more room to grow.

Since penny stocks trade at a lower price point, an incremental movement in their value could translate into a high percentage share price change quite easily.

So, because these shares tend to be more volatile, there’s a higher level of risk associated with buying or trading them. Always ensure you take steps to manage your risk when trading or investing in penny stocks.

Risks and rewards of penny shares

There can be substantial risk when trading or investing in penny stocks, which don’t entirely exist when taking a position on bigger companies. However, there are also potential rewards.

• There’s a possibility that stocks could be undervalued (as they belong to smaller companies), which means more room for share price growth
• You can get exposure to a large amount of shares at a relatively low cost
• Higher volatility creates both traditional trading (buying) and short-selling opportunities
• Penny stock companies don’t always have a proven record of success
• Penny stock companies tend to be small and prone to bankruptcy
• The time it takes for traders and investors to make profit could be longer when trading penny stocks compared to larger stocks
• There can be a risk of potential price manipulation

How can you trade or invest in penny stocks?

1. Learn more about penny stocks
2. Decide whether to trade or invest
3. Create an account or log into your existing account with us
4. Take steps to manage your risk
5. Open your position

With us, you can trade or invest in penny stocks. This means you can either speculate on the share price movements or own the shares outright.

If you want to trade penny stocks, you’ll do so using spread bets and CFDs. When using these derivative products, you can speculate on upward or downward share price movements – ie you can go long or short.

Plus, you’ll trade using leverage, which means you only have to commit a percentage of the trade value to open a position. The deposit you’ll use is called margin.

It’s important to note that leverage could increase your risk, as any profits and losses will be based on the full position size and not the margin used to open it.

If you want to own physical penny stocks, you’ll do so via our share dealing platform. With us, you can invest in shares from zero commission.¹ You’ll need to commit the full value of your holding upfront and you’ll only make a profit if you sell the shares for more than the original buy price. When investing, your loss is limited to your initial outlay.

It’s important for traders and investors to do their due diligence on companies. In other words, they should do technical and fundamental analysis, and take steps to manage the possibility of losing their capital. This is called risk management.

Learn more about how to trade or invest in stocks, or buying shares with us

Penny shares and risk management

Because penny stocks are particularly volatile, you’ll need a good risk management strategy. This could include adding stops and limits to your position to lock in possible profits and limit any losses.

A stop order is a tool that sets the condition for a position to be closed when the market price moves below a certain point. So, if the market price moves towards a less favourable point, the stop will be triggered, and the position will be closed to mitigate further loss.

You can choose between a normal stop or a guaranteed stop. The latter will incur a fee if triggered, as it protects against any possible slippage, too.

You could also set a limit order, which will open a position (either buy or sell) at a price that is more favourable than the current market price. You can place a limit order to avoid monitoring the markets but still execute trades according to your preferred parameters.

How do penny stocks go public?

Penny stock companies that meet the basic requirements to list on an exchange will go public through an initial public offering (IPO) or by means of a SPAC.

An IPO is a lengthy process that includes audits, valuations and various registrations. The news of an IPO will often be released a few months before the planned listing – giving you some time to study the company’s financials. A SPAC is a ‘special purpose acquisition company’ – a publicly traded shell company that raises money to merge with a private company and take it public. In some cases, a company may skip the whole process by directly listing on the stock exchange.

You can use our IPO trading platform to spot the next company that needs to raise capital to increase profitability.

You can learn how to trade an IPO before you make the decision to put capital on the line. We have a list of upcoming IPOs that you can compare, and trade or invest in if you think it shows promise.

Penny stocks summed up

• Penny stocks are shares of smaller companies that are traded for less than £1 in the UK or $5 in the US
• Penny stocks tend to be volatile, due to low liquidity and little information known about the company
• Traders and investors are attracted to penny stocks because they could offer growth opportunities
• You can manage the risk involved in trading and investing penny stocks by doing fundamental and technical analysis before taking a position
• You can trade penny stocks via spread betting or CFDs, or invest in them using our share dealing platform

Footnotes:

¹ Trade in your share dealing account three or more times in the previous month to qualify for our best commission rates. Please note published rates are valid up to £25,000 notional value. See our full list of share dealing charges and fees.