Trading on penny stocks

Also known as penny shares, they are companies that trade for less than £1 on UK stock exchanges and have a market cap below £100m, or trade for under $5 on US stock exchanges​ and have a market cap under $300m. Most do not trade on large stock exchanges, but instead on over-the-counter (OTC)​ transactions, meaning that in the UK, these tend to be listed on the FTSE Alternative Investment Market (AIM) index.

While their very low prices appeal to traders, they carry a high risk. Many are new or recently established companies with the potential for growth but tend to be highly volatile. It’s therefore essential for traders to do due diligence before engaging in penny stock trading. With the right strategy and the ability to spot a blue-chip in the making, traders can enjoy large returns. However, they are more prone to bankruptcy, meaning you could lose all your money.

As penny shares are small companies with few shareholders, it doesn’t take much buying and selling activity to make their share prices fluctuate. And because they are so cheap, one speculative trader’s bulk buy can often shift the price considerably. It is therefore quite common for a penny stock to leap or plunge as much as 20% over a short period of time.

This presents traders with an opportunity to make a significant profit very quickly — or make a huge loss. It can be easy to be sucked into a trade based on a one-day price spike, but the price is just as likely to plummet 24 hours later. It is essential to conduct a thorough analysis while following your risk-management strategy before deciding to embark on a trade. Here are some advantages and disadvantages of trading on penny stocks.

At CMC Markets, we offer leveraged trading, which means that you only have to put down an initial deposit, known as margin, to gain exposure to a much larger trading position. When trading via derivatives, you also don’t take ownership of the underlying stocks.

The two types of leveraged trading products that we offer are the following:

Spread betting is our most popular product, allowing you to trade tax-free in the UK and Ireland*. Spread betters may place a bet on which direction they think a penny stock will move by opening a long or short position. Depending on which way the market moves, you will either make a profit or equal loss.

Contracts for difference (CFD) are another popular method of leveraged trading. CFD traders speculate whether they believe the asset will fall or rise by entering a contract stipulating that the buyer must pay the seller the difference between an asset’s current value and its value when the contract expires. Profit and loss are based on the difference between these two values.

Let’s use an example from the chart below.

A trader may think that shares in Company A, priced at £0.70, are going to rise. So, they decide to buy (open a long position) and within a couple of hours, the stock price goes up. They decide to exit at £0.80 and make a £0.10 profit on each share.

The share price then falls, proving that the trader made the right decision. But later in the day, they spot another opportunity in Company B for £0.60 and place a buy order believing that the price will again rise — but this time, the share price goes down. The trader is concerned that it will fall further so they decide to sell at £0.40, having made a £0.20 loss.

But, because penny shares are so volatile, after they sell, the price goes up again to £0.70, meaning that if the trader had hung on a little longer, they could have made a £0.10 profit.

Trading opportunities can include both stocks in the UK, as well as those in other countries. Here is a penny stock list for those trading for under £1 in the UK and $5 in the US.

As with higher value assets, there are several ways that penny share trading can realise profits, but the risks mean some approaches are generally more suitable than others.

As the name suggests, you would enter a position and then keep it open in the hope of gaining profit over time. The volatile nature of penny stocks means that the longer you keep the position open, the more likely any immediate gains will be wiped out.

It’s possible to make money shorting stocks​ but the market’s volatility means a high-volume position could also lose you a lot of cash very quickly. A short seller would look for a small-cap share and open a sell or short position if they expected its share price to fall, tending not to hold the position for a long time. However, this strategy comes with many risks, especially for beginners.

Another suitable approach is day trading, simply because share prices go up and down so quickly. With this strategy, you would have to swoop fast to maximise any profit, opening and closing multiple positions throughout the trading day.

Not every stock has a low market cap. Some large-cap companies​ trade under the penny value threshold. Rolls-Royce’s market cap is around £7.5bn but in May 2022 it was trading at 80p per share. Lloyds Banking Group’s market cap is over £30bn but it traded under 1p after the 2008 financial crisis. These companies have long histories, make a profit and their share price does not tend to jump around.

So, are these firms considered penny stocks or not? There is no concrete answer.

While most are young and vulnerable companies, other older firms are trading at that level because of recent misfortunes or other circumstances. Rolls-Royce’s share price has been in steady decline since Covid-19 hit the aviation industry, but with the worst of the pandemic behind us, its fundamentals suggest it has the potential to build steadily back up again. Lloyds’ most recent profits exceeded market expectations and its position as the UK’s largest mortgage lender give it a secure future.

Some large companies finding themselves in penny stock territory are in terminal decline. Others, like Rolls-Royce and Lloyds, have strong fundamentals that make them attractive to those looking for longer term gain. In this sense they are not what most traders would consider penny shares, which lend themselves to short-term trades​ — but any large market cap companies with a low share price may potentially provide a bargain. As with any other stock, you should research the company itself. However, those with a higher market cap may take longer to realise a significant return.

Trading on penny shares is a relatively easy and straightforward process for both beginners and experienced traders. Our trading platform, educational resources and supportive client services team help our clients truly understand the markets, enabling them to realise their potential and make the most of their experience.

New to spread betting and CFDs? Set up your own risk-free demo account here, which gives you £10,000 of virtual funds to practise trading with before you commit to the live markets.

Whatever type of trader you are, our Next Generation platform can be personalised for your individual trading needs, combining cutting-edge trading tools with a straightforward interface.

It also comes in the form of a mobile app​ which enables you to trade on-the-go. Available for iPhone, iPad and Android, our trading mobile apps include full order-ticket functionality and advanced charting, specifically designed for mobile devices.