While there can be sizable gains in trading penny stocks, there are also equal risks of losing a significant amount of an investment in a short period.
Everybody likes a bargain, and stocks with low share prices certainly seem like bargains. With some high-priced stocks costing hundreds or even thousands of dollars for a single share, trading penny stocks can be a tempting way to try to grow your money quickly. While there can be sizable gains investing in penny stocks, there are also equal risks of losing a significant amount of an investment in a short period.
There is quite a bit you should know before you dive in. If you want to invest in penny stocks right away, here is a quick guide that can help:
- Research your penny stocks – Shortlist the best penny stocks for 2023 using strict criteria in order to pick the good businesses from the bad businesses.
- Define your strategy – trading lets you speculate on the price movement; dealing lets you take direct ownership of the stocks.
- Take your position – create an account with us to buy and trade in penny stocks listed on 10 global exchanges.
The exact definition of a penny stock varies, but typically they include stocks trading for less than $5 per share all the way down to even fractions of a penny. But usually, when people say penny stocks, they’re talking about those that trade for less than a dollar. Despite this lower price, penny stocks often don’t trade as many shares as their higher-priced rivals.
The US Securities and Exchange Commission (SEC) has formally defined a US penny stock as one with a share price below $5 per share, having previously been a stock below $1 per share beforehand. The EU and UK do not have their own formal definition although a penny stock is generally considered to have a share price of below €1 or £1.
Penny stocks are regarded as a more speculative investment than larger businesses because they are geared for growth and often loss-making, with many yet to generate any income or develop a viable product or service. As they are small, low-valued businesses, they offer higher risk and reward to traders. Many of these are quoted over the counter (OTC) but some also trade on exchanges.
Understanding penny stocks
Penny stock investors often erroneously think that a low share price indicates that the company has greater potential to grow than those with higher share prices. The valuation of a company -- also known as its market capitalization -- is determined by two factors:
- The stock price
- The number of shares outstanding
That second factor is crucial because how many shares to issue is entirely up to the company. One million shares outstanding at $100 per share is worth exactly as much as 100 million shares outstanding at $1 per share. Moreover, a company with a $100 share price very likely has much stronger growth potential than a company with a $1 share price.
Professional investors measure how expensive a stock is by comparing it to its earnings (the P/E ratio) or other similar metrics. That is, what your share in the earnings of the business is for the price that you pay for that share. On this basis, a profitable company whose stock trades at $200 is much cheaper than an unprofitable penny stock at any price.
Alternative ways to invest on a budget
It is possible to achieve strong returns by investing in young companies with small valuations or depressed stock prices, but typically it’s better to invest money only in companies that are larger and have less speculative valuations. Any risky stock buys should at least be limited to shares of companies that generate meaningful revenues -- or are pursuing clear, realistic paths to growth.
However, according to experts, there are better alternatives to penny stock investing. Thanks to the rise of fractional share trading, which enables purchases of less than one share, you can often invest in stocks for which the share price is extremely high. For instance, a single share in a company like Alphabet (GOOG) costs thousands of dollars, but you can buy any fraction of a share and still gain portfolio exposure to the stock's future performance.
ETFs are another affordable option for those on a budget, and they enable you to quickly diversify your portfolio as well. They're designed to mimic the performance of a market index, like the S&P 500, and so they end up with similar returns to the index itself or invest in a basket of stocks within a sector or specific theme.
What are the best penny stocks to trade?
There is an array of penny stocks operating in a broad range of industries for investors to choose from, including some names that will be well-known to investors and consumers. While some penny stocks are small firms chasing growth there are some big names that have subsequently become penny stocks following steep falls in value.
If you’re interested in penny stocks, you’ll need to be an excellent analyst who can pick good businesses from bad businesses.
Juventus (MTA: JUVE)
- Price: €0.28
- Market Cap: €700M
Juventus is one of three Italian teams listed on the stock market, alongside Roma and Lazio. JUVE's share price has delighted investors over the past five years, growing by more than 570%. Many say this happened because the club signed Cristiano Ronaldo, dubbing it ‘the Ronaldo effect’.
On the downside, Juventus football club has a lot of debt, which some say is due to the high wages it pays. Contributing factors to its piling debt include the negative impacts of the Covid-19 pandemic, which has meant game-day revenue losses, a decrease in product sales, and more.
Juventus Football Club's stock fell 40% on the Milan Stock Exchange at the end of 2021 in the wake of an alleged fraud scandal.
Italian authorities raided the club's offices to collect documents relating to the accounts for the 2019-21 period as part of an investigation into club president Andrea Agnelli, vice-president Pavel Nedved and former sporting director Fabio Paratici, among others, over allegations of accounting fraud in player transfers causing Juventus shares to collapse.
However, according to valuation, JUVE shares are highly undervalued. The fair value is 0.65 EUR per share, while the actual market price is 0.28 EUR per share.
Nokia (HEL: NOK)
- Price: $4.80
- Market Cap: $32B
Amid drastic changes to its business, Nokia continues to attract investor attention. Once the leading maker of mobile phones, it has redefined itself as a telecom equipment stock in the 5G era. Moreover, it has recently drawn attention from traders on Reddit as a meme stock, in part due to its low per-share price.
Nokia has traded much higher historically, reaching $62 per share at the height of the dot-com bubble in 2000. In addition, shares sold for as much as $42 when its cell phone business peaked in 2007.
Moreover, Nokia has about 5.6 billion shares outstanding. With so many shares available, gains become more difficult as it takes large stock purchases to move the price.
This oversupply of shares points to a key difference with other low-priced stocks. Most companies trading in the $5 per share range are either small or mid-cap companies. Nokia has a market cap of about $32 billion -- well into the large-cap territory.
Aegon (AEX: AGN)
- Price: €4.7
- Market Cap: €10B
Aegon is an insurance company based in the Netherlands, with operations focused on the Life segment and with operations in several geographies. It has a market capitalization of about $10 billion and trades on the New York Stock Exchange.
Its business is well diversified, offering a full range of life insurance and other financial services to its customers. Despite being a European company, the U.S. is the company's largest market, being responsible for some 42% of earnings. The Netherlands is the second-largest market (34% of earnings) and the U.K is the third-largest market.
Aegon had many fundamental issues in the past, which are now mostly addressed. Its improved financial profile, good capitalization, and attractive dividend yield make it a good income play right now.
Aegon's stock price is currently undervalued and has good dividend growth prospects, becoming potentially a high-dividend yield company in the next three years, an improved profile that doesn't seem to be reflected in its penny stock valuation.
WISH.COM Inc.(NASDAQ: WISH)
- Price: $4.20
- Market Cap: $400M
ContextLogic (Wish) was one of the most popular stocks among retail investors during the meme-stock craze of 2021. However, shares of the e-commerce company, which owns the Wish platform, have plummeted by 97% from its peak in late January 2021, shortly after it became a publicly traded company.
However, there are good reasons for this penny stock valuation. Regrettably, nearly all of the company's revenue generation and profitability metrics have gotten worse. And it hasn't helped that the macroeconomic scenario is especially unfavorable for companies with no earnings history, either.
Despite its weak business fundamentals and difficulties in making profits, investors may want to consider buying shares of the company while it has a penny stock valuation. Even with all the difficulties and burning through $361 million in operating expenses last year, the company has almost $1 billion in cash and virtually zero debt.
The company also has some valuation metrics that aren't bad, either. The company's price-to-book ratio is 0.8, versus a retail industry average of 4.7. And ContextLogic's enterprise-value-to-EBITDA ratio is 1.5, versus an industry average of 24.3.
The metrics indicate that WISH may be quite undervalued. But the company has work to do. Its operational risk is the most worrying because the Wish platform continues to lose users, record revenue losses, and struggle to address serious problems in consumer experience and delivery times.
Atara Biotherapeutics Inc. (NASDAQ: ATRA)
- Price: $4.20
- Market Cap: $400M
Atara is a biotherapeutics company utilizing T-cell immunotherapy to develop therapies for patients with solid tumors, blood cancers and autoimmune diseases. T-cells are a specific type of immune cell.
Investopedia ranks ATRA as the best penny stocks as ranked by a growth model that scores companies based on a 50/50 weighting of their most recent quarterly year-over-year percentage revenue growth and their most recent quarterly YOY earnings-per-share (EPS) growth.
The revenue growth is estimated at 1.230%.
Banco Sabadell (MAD: SAB)
- Price: €0.9
- Market Cap: €10B
Banco de Sabadell, S.A. is a Spanish multinational financial services company headquartered in Alicante and Barcelona, Spain. It is the 4th-largest Spanish banking group. It includes several banks, brands, subsidiaries, and associated banks.
According to Spanish analysts, Sabadell's better share performance relative to other Spanish banks is explained partly by reports of bids for its payment unit, now pointing to a higher price than previously expected.
Banco de Sabadell’s earnings over the next few years are expected to grow, indicating bright prospects for the company.
- Price: €3.5
- Market Cap: 400M
Borussia Dortmund listed its shares on the Frankfurt Stock Exchange in 2000, using the ticker BVB. It’s the only German football club that’s publicly traded. When it listed, it floated 15 million shares at a price of €11 a share. Unfortunately, the shares didn’t perform well for the first ten years, but it became a popular share to watch among short-sellers during that time.
In addition to commercial, brand and broadcasting deals, Borussia Dortmund also makes money from other channels such as sports equipment manufacturing and its investment in a travel agency.
BVB shares lost 60% of their value since the COVID 19 pandemic which affected most sport brands all over the world. Based on analysts' forecasts, a long-term increase is expected.
AirFrance (PAR: AF)
- Price: €1.3
- Market Cap: 3.3B
AIR FRANCE-KLM is an airline company. The Company's core business is passenger transport, cargo transport, and aircraft maintenance services. The Group is the world leader in terms of international passenger traffic; and its cargo activity (not including integrators) and is one of the world's major maintenance service providers.
The Group structure is simple: a holding company with two airline subsidiaries. Air France-KLM has established a set of clearly defined commitments to ensure that its strategy of profitable growth goes hand in hand with environmental quality and social progress.
Analysts consider AIR FRANCE undervalued based on valuation methodology reviewing the firm fundamentals such as profit margin of (2.67) %, and Return on Equity of (111.99) % as well as analyzing its technical indicators and Probability Of Bankruptcy.
Note: While investing in penny stocks, investors must remember one has to be diligent in their research and invest their entire corpus in a diversified manner to hedge against potential risks that come with higher return prospects of penny stocks.
Advantages of Investing in Penny Stocks
Due to their low volume, penny stocks tend to be more volatile than established equities. This means high opportunities for both gains and losses, and investors should be careful to understand both the risks and benefits.
Potential for High Returns
Most penny stocks have tiny market capitalizations, meaning it takes a small amount of money to move their share price substantially. Therefore, positive news, such as signing on a major customer or forming a new strategic alliance, can lead to sizeable returns before the mainstream investing world discovers the stock. Conversely, negative news can lead to significant losses.
Penny stocks attract investors with a small amount of trading capital as their lower share prices allow them to buy thousands of shares. For example, if an investor has $500 to invest, they can purchase 2,000 shares of a penny stock trading at 25 cents. If that stock doubles over a month, the investor makes a quick 100% return on their investment. However, with the same starting capital, the investor could afford only a small number of shares in most USA 500 stocks, making it almost impossible to achieve those gains over the same period.
Risks of Investing in Penny Stocks
However, some factors exacerbate the risk associated with investing in or trading penny stocks. These securities are usually riskier than more established companies.
Penny stocks often trade on thin volume, meaning it can be difficult for investors to enter and exit their positions. Moreover, these stocks typically have a wide spread between the bid and ask, which increases trading costs. For example, if a penny stock has a bid price of $1.00 and an ask price of $1.50, a trader wanting to buy at market gets caught paying a 50 cent per share premium. Therefore, investors should use limit orders to minimize trading costs when buying and selling penny stocks.
Penny stocks that start moving rapidly higher in price show up on stock screeners and may even get media attention. This often attracts more speculators who push prices up even higher, leading to unstainable valuations. For instance, during the dotcom bubble in the late 1990s, many penny technology stocks doubled and tripled in price despite not generating any earnings. However, when the market turned bearish a few years later, many Nasdaq-listed penny stocks with unsustainable valuations fell substantially or were delisted.
How to Invest in Penny Stocks
There are two routes to investing in penny stocks: speculating on their prices using leverage or buying the assets in the hope they increase in value.
Trading penny stocks
In leveraged trading, you agree to exchange the difference in the price of an asset from when you first open your position to when you close it. You are speculating on the price of the market rather than taking ownership of the stocks. If you open a long position and the stock or ETF does increase in value, you’ll make a profit, but if it falls in price, you’ll make a loss – the opposite is true for a short position.
Buying penny stocks and ETFs
This means that you take ownership of a portion of the company or fund outright, with the intention of holding it with a brokerage and profiting if it increases in value.
Exchange-traded funds (ETFs) like iShares Microcap ETF allow you to invest in a basket of selected penny stocks at once as opposed to any single company. ETFs are traded much like ordinary stocks.
Get Started with CAPEX.com
Here is how to trade and invest in penny stocks with an international, highly regulated broker like CAPEX.com:
- Choose which type of account you want to use. Your first concern should be your risk appetite and time horizon. If you want to buy and hold penny stocks, open an investing account. If you want to speculate on price movements (including falling prices) with zero commission and leverage, open a trading account.
- Create an account. Regardless of your chosen account, you need to register and complete the KYC process to verify your identity.
- Fund your account with fiat money. Before buying and trading any penny stock, you need to fund your exchange account with U.S. dollars, Euros, or other currencies.
- Select your stocks. When selecting penny stocks, consider the number of shares available, share liquidity, and the risk of dilution if there are too many shares outstanding. Alternatively, investors can buy shares in micro-cap ETFs.
- Place a buy order for your chosen stock. Follow the steps required by the trading platform to submit and complete a buy order.
When trading stocks, the contracts are stored in your account and are more liquid than the underlying asset. However, you should be aware that trading is fast-moving and requires close monitoring. As a result, traders should be aware of the significant risks when trading. There are liquidity risks and margins you need to maintain; if you cannot cover reductions in values, your provider may close your position, and you'll have to meet the loss no matter what subsequently happens to the underlying asset.
While penny stocks are volatile, there are some cautions that an investor can take to reduce their downside risk. One is to conduct proper due diligence: Since penny stocks tend to trade in venues with lower entry requirements, investors should take extra care to read the company's statements and ensure that the company is financially sound.
It is also important to rely on reputable stockbrokers. While there are scams to watch out for, most of them are promoted by dubious emails and cold calls. A reputable broker should be able to provide high-quality written research to back up any investment claims.
Finally, as with any speculative investment, never put in more money than you can afford to lose.
Before you start investing and trading in penny stocks, you should consider using the educational resources we offer like CAPEX Academy or a demo trading account. CAPEX Academy has lots of courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader or make more-informed investment decisions.
Our demo account is a suitable place for you to learn more about leveraged trading, and you’ll be able to get an intimate understanding of how leveraged trading works – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for stock investors who are looking to make a transition to leveraged trading.