Penny stocks can be very risky.

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Penny stock trading is a risky technique. The upside is large, but trading cheap stocks can lose you money! The adage "buy low, sell high" is good advice, but there's nuance to it. Similarly "sell high" doesn't mean "wait for it to become the most expensive stock possible". In securities, low and high are relative terms which refer to the underlying value of the business itself: Novices commonly fall into the trap of looking for penny stocks to buy.

Penny stock trading is a risky investment strategy that looks for very cheap stocks and tries to exploit big changes in their prices. Penny stocks generally sell for less than five dollars per share and trade outside of a major exchange. These stocks are cheap for a reason: These stocks are popular in certain circles, but they're very risky.

You might also hear them referred to as microcap stocks or pink sheet stocks. It's all the same thing. See the SEC's penny stock rules for more detail warning; regulatory language. You can buy or sell them through an online broker, however—if you're willing to take on the risk. In theory you can sell a penny stock at any time, but you have to find a willing buyer for the price.

Hold that thought in your mind for a moment. These cheapest stocks may seem like a good value for your money. Which would you rather have, seven shares or two thousand? The problem is that the value of a stock depends on two things.

First, its value is whatever someone's willing to pay for it. With millions of shares changing hands every day, millions of people are judging what stocks are worth.

Two, the value of a stock depends on the value of the business behind it. It's much better to own a company that's making money than it is a company that's losing money. People are willing to pay a little more for the privilege of owning part of a successful business than they are to own part of a failing business.

Most of the time, a stock price below a dollar means that people think the business is in trouble. Most of the time, they're right. Even if you've found likely candidates, penny stock trading is one of the riskiest types of investing.

Ironically, sometimes the cheapest stock to buy may be the most expensive stock to own—when you can't sell it for what you paid for it. In NovemberAmerican Airlines filed for bankruptcy. Its stock shed value and dropped to pennies per share.

Yet that's one success story out of countless failures. In bankruptcy, anyone with a claim on the assets of the bankrupt entity gets to negotiate on the terms of their payment. As the holder of a share of common stock if you don't know what that means, you're definitely a holder of common stock you're at the lowest place on the list. You have almost no say in what happens to the business's assets. If the company is in so much financial trouble that there's no chance it'll be able to pay off its debts, it may have to be broken up and have all of its assets sold off to its creditors.

You're not getting any money out of that. You're not making percent returns. American Airlines didn't go out of business. Instead it merged with another company. Sometimes that happens, or sometimes a stock gets bought out entirely as was the case with Orchard Hardwarewhich Lowe's bought in late In that case, the acquiring company will often make a bid for the troubled company, based on what they think the company is really worth.

That's probably the value of the assets: In the case of an acquisition, the acquiring company may either pay existing stockholders a fixed price per share or convert shares of the acquired stock into shares of the new parent company at some ratio. Sometimes this is a good deal. Sometimes it's a fair deal.

Any profit you make depends on the price you paid. If it's below the acquisition price, you might make a little profit. In this situation, timing is everything. You must buy the stock for less than what it will sell for. How do you know what it'll sell for? You have to figure out what the company as a whole is worth—its inventory, any existing contracts, any investments, the value of real estate, and the opportunity costs of acquisition.

That's a lot of financial analysis for a company that'll probably go bankrupt. Of course, to buy a stock at the right price, you have to find someone to sell it to you at that price.

Unlike a normal stock, where people buy and sell based on actual value of what the company can actually make, penny stock trading relies on speculation.

Everyone who owns the stock is waiting for it to turn around somehow. The same goes for getting out of a stock.

Penny stocks have very little liquidity. There aren't many buyers and sellers because they're so risky. Unlike a share of Coca-Cola stock you can buy or sell pretty much anytime near the asking price, there aren't enough buyers and sellers who agree on prices, so their prices have wild swings. You're going to have to have great timing and even better luck to sell at the price you had in mind.

That's after you've gone through all of the hoops in buying these shares in the first place. Sure, you can wait for the company to turn around—but most don't.

Most don't get acquired. Most go out of business. Day trading penny stocks will be frustrating when that lack of liquidity works against you. If you're at all ethical—if you're not defrauding other people with pump and dump scams—you're relying on luck, and luck is a poor investment strategy.

As well, patience works against you. You have to race around the clock before these poor companies go out of business altogether. That "hot penny stock tip" you just saw in email?

That's someone's desperation trying to trick you into buying what he really really wants to sell. You can generally buy microcaps through any reputable stock brokerthough you'll likely have to sign a disclaimer that you understand the risk of smallcap trading. In shadier corners of the Internet, you can find businesses which purport to specialize in these trades, but trust may be an issue.

Any reputable stock broker will have to run you through several pieces of paperwork to ensure that you understand the risks of this type of investing. Their companies are often in bankruptcy. It's very difficult to find the fair valuation of a business in financial trouble, so you don't know the right price to pay. You're also a creditor probably last in line for liquidation, so if everything goes wrong and the stock goes out of business, you might lose all of your money or get ten cents on the dollar.

Turning around a troubled company takes time. You have to be patient. Good returns are rare, and they're smaller than you might think. Turning a company losing millions of dollars a year into a company making millions is a lot of work! It's difficult to buy and sell penny stocks for good prices. You don't even know what the right price is or the right price will be.

You're competing with a lot of other people trying to outsmart each other. Finally, many of the people promoting these stocks are really making money from convincing you to subscribe to a penny stocks newsletter. If there's a really great underpriced stock, would you want other people to swoop in and buy it and drive up the price? Maybe—if you want to sell it to them at inflated prices!

It's especially insidious when you have to pay to subscribe to this hot penny stock newsletter. You're giving someone money to market their worthless stocks to you!

If good penny stocks are out there for the taking, they'll all have several characteristics. The best penny stocks:. The latter is the most important, as there's no point in buying a stock that's about to go out of business. Don't fall for the hype. Making money by investing is a matter of time and patience and looking for true value—buying good businesses. You never need to pay anything besides discount broker commissions. No secretive broker will help you get wealthy with cheap stocks.

Successful investors aren't day trading penny stocks. No hot cheap stock lets you make incredible money in a week; anyone who tells you otherwise is gambling. What is Penny Stock Trading? What is a Stop Loss Order?

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The name 'penny stocks' was originally given to stocks that had a share price of less than a pound. These days the term has been expanded to cover stocks that are valued over a pound as well, but generally penny stocks have low share prices. They are usually characterised by high volatility and are seen as high-risk stocks but with the possibility of significant growth. The appeal of penny stocks and shares is easy to see.

And of course, if your penny share one day goes on to join the blue chips, you will end up making many hundreds of percent return. If we add into the mix the folklore of a friend of a friend of a friend — or to bring it more up to date, someone on the internet — who made a million or more from penny shares, their appeal is cemented. But before you get caught up in the thrill of penny stocks, take a breath and a step back. Penny shares are normally penny shares for a reason — they usually don't make very good investments.

The company may have been losing money for years, or it may be in a highly speculative industry mining is always a popular one.

The penny share speculator needs to go in with their eyes open. The suggestion to do your own research is often quoted when it comes to investing in stock markets, and is probably even more true of penny stocks. As they tend not to see too much daily volume on stock markets, it often doesn't take a large buy or sell order to move the price.

If plenty of people are talking about a penny share down the pub or more likely on internet chat rooms, that can also influence the price.

It's important not to get sucked into an investment just because it has had a large one-day move and you are afraid of missing out. What goes up quickly can come down even quicker — so make sure your reasons for investing are the right ones. Although penny shares are cheaper per share than the major companies, the costs can end up being more, as a percentage of your total investment.

This means the penny share has to rise more for you to actually make a profit. It can mean that if you change your mind very quickly about the investment, you end up taking a bigger loss than you were banking on.

This is another important point to consider when trading in penny stocks. If you are happy with your research and have gone ahead and made your investment, another key point is: It can be very easy to sit back and wait for it to double once more. When sentiment changes on smaller shares it can perform an about-turn very quickly, taking all of your hard-won profit, and maybe more. Getting in to the position is only half the plan of investing, in fact some would say it actually accounts for less than that.

Where you get out will determine just how successful penny stock trading will be for you. Disclaimer CMC Markets is an execution-only service provider. The material whether or not it states any opinions is for general information purposes only, and does not take into account your personal circumstances or objectives.

Nothing in this material is or should be considered to be financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. CMC Markets does not endorse or offer opinion on the trading strategies used by the author.

Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

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Learn forex trading Forex trading examples Forex technical indicators Using leverage in forex trading Benefits of forex trading What is forex? How do I fund my account? How do I place a trade? Do you offer a demo account? How can I switch accounts? Create an account Trade over 9. Open a demo CFD account. How to trade penny stocks. Finding the right stocks But before you get caught up in the thrill of penny stocks, take a breath and a step back. Fundamental analysis The penny share speculator needs to go in with their eyes open.

Keep an eye on trading costs Although penny shares are cheaper per share than the major companies, the costs can end up being more, as a percentage of your total investment. Securing your profits If you are happy with your research and have gone ahead and made your investment, another key point is: Live account Access our full range of markets, trading tools and features.

Open a live account Losses can exceed your deposits. Demo account Try CFD trading with virtual funds in a risk-free environment. Open a demo account. Sign up for free. Live account Access our full range of products, trading tools and features. CFD trading can result in losses that exceed your deposits. Ensure you understand the risks.