We all like a good bargain, which is why many people look for stocks and shares that have low prices. Whilst some stocks and shares can cost thousands of pounds, it can seem almost too good to be true to find stocks that only cost a few pence to buy. However, as with many other things, a low price tag doesn’t always equal a good investment.
It can often seem like a good idea to invest in smaller companies with lower stock prices as you may expect to see a high return when the company grows. However, this can often be a risky move and may end up with you losing rather than gaining money.
Penny stocks catch the eye of many people who are looking to invest their money. Whilst these cheap stocks can result in a good return, there are some things that you will need to be aware of before you part with your hard-earned cash.
In this article, we’ll look at what penny stocks are, why you may want to consider investing in them and the risks that are often associated with these types of stocks.
What are penny stocks?
Penny stocks are small common shares that can be bought for less than £1 in the United Kingdom. However, even though the price of these shares is so low, they aren’t as frequently bought as other shares. They have a high-risk factor which warns off many would-be investors.
This type of stock doesn’t belong to one particular industry as there are lots of companies that sell shares for less than £1. For this reason, it can be hard to tell whether a penny stock is a good investment or not because it can be linked to so many different types of business models. Many smaller businesses sell penny stocks, especially companies that have been newly established.
There are many advantages to buying penny stocks, although there are some things to be wary of too. We’ll take a look at what to consider when trading penny stocks and how you could potentially see a good return on your investments.
What are the advantages of penny stocks?
Penny shares are more affordable than other types of shares, which means that you can buy a large amount for a relatively low cost. This also means that you could gain a large sum of money from a small amount of capital if the company and shares do well.
Due to the cost of penny shares, they are usually quick and easy to trade as they aren’t a costly investment. They have the potential to earn you money in a short space of time, even though you may have only invested a limited amount of money to buy the penny stock.
You may be able to buy a number of cheap shares that increase in value as the company’s trading improves and they begin to make a good profit. It’s a good idea to buy stocks when a company is selling their stock for a low price, but its industry is flourishing and its prospects are good.
What are the risks of penny stocks?
Trading penny stocks can be risky. Most penny stock investors struggle to cash out when they want to sell their shares because there is a lack of buyers on the market. Although penny stocks can gain value, they can also lose value very quickly. The one thing to remember when you invest in penny stocks is that the prices can fluctuate and therefore can be hard to predict.
Some penny stock companies also trade penny stocks that don’t have any real value. The companies are trying to make a quick profit and are therefore scamming investors out of their money because they won’t see any return. It’s common for new or small companies to deal with penny stocks trade, which can be difficult as these companies don’t always abide by the same regulatory standards that larger firms do.
A penny stock company may not have a good level of transparency when dealing with these types of shares, which can make it hard for potential investors to find out the relevant information about the company. Many penny stock companies end up going bankrupt because new companies struggle to make a profit or even break even in their first few years of trading.
It can take a longer time for smaller companies to make a profit, which means that investors may have to wait longer to make a profit on what they have invested. There is also a chance that the penny stocks have had their prices manipulated, which could result in you losing more money than you thought was at risk. The penny stock market doesn’t have a proven record of success for a lot of its shares, which means that you could see a high return for a low investment, but you could quite as easily lose money from your investments.
Where are penny stocks traded?
In the UK, many penny stocks are listed on the London Stock Exchange’s (LSE) Alternative Investment Market (AIM). It is renowned for having big successes, but equally where many investors lose large amounts of money. Stocks on this exchange don’t have to follow the same listing standards that companies have to meet to trade on LSE’s main exchange market.
Some penny stocks do trade on major exchanges, such as the US New York stock exchange, but most penny stocks are traded by over-the-counter transaction methods such as the OTC bulletin board, which is sometimes referred to as pink sheets. This is where most stocks are traded if they don’t meet the requirements for listing on a major stock market.
However, whilst the standards are slightly different, companies do have to meet certain criteria before they are able to sell stocks and shares on AIM. The criteria don’t put as much pressure as it does on larger trading companies on the main market.
Are penny stocks more volatile than other stocks?
Whilst penny stocks can see a good return, they are also incredibly volatile. Their worth can fluctuate because of their profitability and their estimated future profitability. Penny stocks rarely show future potential, which means that they may show an increase from time to time but not enough to show long-term value and good returns.
Penny stock prices can experience large swings as news of the stocks are released, and investors flock to buy them. However, penny stocks have limited liquidity as there is a lower volume that is regularly traded and therefore a significant purchase can have a major impact on the stock levels. Less volume means that investors may struggle to sell their stocks at a decent price when they decide they want to trade.
The lack of information about the companies and their penny stock combined with their low liquidity means that these types of stocks are often subject to price manipulation. Individuals will sometimes buy a large number of stocks so that the price inflates, which scammers will then promote on social media and other online platforms to pretend that the stock is a worthy investment.
There are fewer ratios and reports about these types of stocks, which can make it difficult to judge whether buying certain stocks is a good investment or not. It can be incredibly difficult to verify the available information and conduct background checks on the company’s history, especially when the information is from untrustworthy sources.
FAQs
Can you make money with penny stocks?
As penny stocks are so volatile, they aren’t a sure way to make money. You may see some good returns, but it can take a while for small or new companies to turn a decent profit and many of these companies end up going bankrupt. It’s equally a good idea to be aware of scams and to be wary of investing until you have conducted proper and detailed research into the company.
Although it may sound obvious, the best companies to invest in are the ones making a lot of money. Companies that are losing money are a bad investment and are best avoided. However, functioning companies that make a lot of money tend to sell their stocks for a high price.
Most penny stock companies don’t want to sell penny stocks long term, so they will usually have a strategy in place of how they want to grow the business and then be able to list on a major exchange. To do this, the companies must have a decent cash flow and not fall back on liquidating to placate their creditors.
Companies that want to grow will be more likely to aim for long-term business and pay back their investors. Most new and small businesses need to find their footing so, in the meantime, they may be restructuring and selling their stocks for a lower value. This is often a good time to invest as the business is on the upswing, and yet the stock prices are still low and a good investment opportunity.
Some investors may be tempted to ‘pump and dump’, as it is often called. This means that they buy the stocks at a cheap rate, talk them up online and to other potential investors and then sell their stocks for a higher stock price once interest and value have increased. It is worth looking out for this unethical process and refraining from doing it yourself.
How can you find penny stocks?
It can be challenging to find the right penny stocks that you want to invest in. However, the process of researching penny stock lists and the companies selling the stocks will improve your chances of buying stocks from reputable companies that have a better chance of giving a good return.
There are many websites that provide lists of good penny stock investments, although they shouldn’t be blindly trusted. After finding the names of recommended companies to invest with, it’s advisable to research each company individually to see whether they are the sort of business that you want to invest in.
It’s not a good idea to invest in companies without conducting prior research. Many scam companies will be putting false information online in a bid to get investors. You can’t trust word of mouth either, as you won’t be able to make an informed decision yourself without doing background research.
Summary
Buying penny stocks is a term that describes cheap stock that can be bought for less than £1. Most penny stocks are sold by new and small companies, which increases the risk of the stocks. Although it can seem tempting to buy a large number of stocks, they won’t necessarily show a good return as the company isn’t guaranteed to make a large profit. New and small companies frequently go bankrupt too, which will affect your investments.
Penny stocks are incredibly volatile as some scam companies sell shares that don’t have any real value in the hope of making some quick money. It can also be difficult to conduct background checks on penny stock companies as they don’t have to follow the same regulatory standards as larger companies do on the main stock exchange markets.
It’s advisable to conduct proper background checks before investing money in penny stocks. You may be lucky and make a decent return if the company flourishes and your stock values increase. However, there is no guarantee with these types of shares and you may have to sift through a few scams or financially damaged companies before you are able to find worthwhile companies to invest in.