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eToroHow to Buy Penny Stocks
Written by Brian Nibley
Fact-checked by Joey Shadeck
Edited by John Bringans
Penny stocks are low-priced shares of smaller, lesser-known companies, that trade for less than $5 per share. While their affordability can make them appealing, they come with significant risks. Penny stocks may have the potential to yield substantial gains, but their volatile nature, limited liquidity, and higher susceptibility to fraud make them among the riskiest investments in the market.
My guide covers the fundamentals of penny stock trading, including the risks and rewards that come with these speculative investments. From setting realistic expectations to navigating market pitfalls like pump-and-dump schemes, this guide has everything you need if you want to learn how to buy penny stocks.
What are penny stocks?
A penny stock is defined as a small-cap stock with a share price of less than $5.00. Penny stocks are typically associated with smaller, lesser-known companies that may not be listed on major exchanges like the NYSE or NASDAQ. Instead, they are often traded over-the-counter (OTC) through the OTC Markets Group or via pink sheets.
Penny stocks often carry more significant risks than stocks with higher valuations. While the low price per share makes penny stocks appealing to beginner investors or budget-conscious investors, their lower liquidity and higher volatility can lead to rapid price swings – which can make it more challenging to exit . These factors make entering or exiting positions at desired prices challenging, introducing extra risk.
Newer investors are often drawn to penny stocks, believing that they are an easy way to make quick money. It’s not unheard of for a small-cap company to see exponential growth if its business model succeeds or if positive news drives demand. That said, higher potential rewards also come with higher risk; many penny stocks fail to grow, and some become worthless. Penny stocks are more vulnerable to market manipulation schemes, like pump-and-dump tactics, which I’ll cover later.
Just starting out?
If you're new to investing, there's no better way to get started than by checking out our guide to the best stock trading platforms for beginners. I'd also encourage new investors to practice first by making trades using a paper trading account.
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How to trade penny stocks
Trading penny stocks can be a high-risk endeavor, particularly for traders who are learning how to invest in the stock market. However, by following some key best practices you can increase your odds of success.
1. Only trade what you can afford to lose
Penny stocks are volatile, and many of these investments fail to deliver long-term gains. When first learning how to invest in penny stocks, it’s a good practice to decide on a specific dollar amount you’re willing to risk – and avoid exceeding it. Limiting your exposure can prevent severe financial setbacks if your trade doesn’t go as planned.
2. Trade on major exchanges
While some penny stocks are traded exclusively over the counter (OTC), there are still plenty of stocks under $5 that can be traded on major exchanges like the NYSE or NASDAQ. These stocks are subject to stricter regulatory requirements, making investors less likely to encounter fraudulent or poorly managed companies. Stocks traded over-the-counter (OTC) markets or pink sheets often lack transparency and liquidity, which can increase risk.
3. Do your own research
Reliable information on penny stocks can be hard to find, making due diligence even more important than usual. Avoid relying solely on promotional materials, social media content, or tips from forums. Instead, look for companies with strong fundamentals like a verifiable track record, clear financial reports that indicate growth, experienced management, and a strong position in their industry. Be wary of unsolicited tips, and never buy stocks solely based on trending recommendations.
Pro tip:
Consider it a red flag if you can’t find any detailed third-party information about a company.
4. Be mindful of liquidity and fees
Penny stocks often have low trading volumes, resulting in wide bid-ask spreads that make it difficult to execute trades at the price you want. When trading penny stocks, consider using limit orders (in some cases, your broker may require limit orders for penny stocks). Additionally, ensure your broker offers low or no commission fees for penny stock trades – higher fees can affect your profits (check out our guide to the best brokers for free stock trading). Even though most of the best stock brokers offer zero-fee trades, there can be exceptions for certain securities, like penny stocks.
5. Have realistic expectations
While it can be tempting to chase the idea of big returns for a small investment, the reality is that most penny stocks do not deliver sustained growth. Set realistic goals and focus on trades where the risk-to-reward ratio aligns with your investment strategy and risk tolerance.
Are penny stocks worth it?
Now that you know how to trade penny stocks, you might be wondering if penny stocks are worth the risk. The short answer is that there’s nothing wrong with making a small allocation to well-researched, regulated penny stocks. The key is understanding that these investments can plummet in value and to allocate your funds accordingly (learn more about asset allocation). Ultimately, whether penny stocks are “worth it” comes down to your investment goals and risk tolerance.
It’s important to understand that many penny stocks are tied to companies with little or no revenue, unproven business models, or shaky management teams. This makes it even more difficult to pick winners. Risk-averse traders will likely want to avoid trading penny stocks altogether.
For every success story you hear about someone striking it big with a penny stock, there are countless stories about traders who lose money chasing these high-risk investments. Even promising penny stocks are often subject to extreme volatility, meaning that prices can swing wildly in a matter of hours – or even minutes.
Pro tip:
If you decide to invest in penny stocks, consider setting strict limits on the amount of capital you’re willing to risk and be prepared for the possibility of total loss.
Risks of trading penny stocks
Anyone looking to buy penny stocks should know they are among the riskiest assets available. Because the share price is so low, investors will often buy hundreds or even thousands of shares at once. Minor variations in the share price can, therefore, result in large gains or losses for investors.
Penny stock companies are prone to failure
Penny stocks often represent companies on the verge of bankruptcy or struggling to stay afloat. These businesses typically face significant financial challenges, such as mounting debt, declining revenues, or unproven business models. As a result, they’re highly susceptible to failure, and their stock prices can drop to zero without warning.
Penny stocks typically have low liquidity
Liquidity is another major risk. Because penny stocks are typically thinly traded, it can be difficult to buy or sell shares at your desired price. A large sell order can cause the stock price to plummet, wiping out your investment in minutes. Similarly, the low trading volume makes it harder to exit a position quickly, especially during times of heightened market activity.
Penny stocks are volatile
Lastly, the volatility of penny stocks can be emotionally taxing. Watching prices swing wildly in a single day can lead to impulsive decisions, such as panic selling or doubling down on losing trades. For many investors, the psychological toll of trading penny stocks outweighs any potential rewards.
Avoid being reactive
Bad decisions often stem from excessive greed or fear. By only investing cash that you don’t need for survival or emergencies, many of those mistakes can be more easily avoided. For more tips on avoid these mistakes, check out our guide on how to manage emotions while trading.
In short, penny stocks are not for the faint of heart. If you’re unsure whether or not you want to learn how to buy penny stocks, the safest bet would be not to do so. If you do choose to trade them, remember to conduct your due diligence, be on the lookout for signs of fraud, and only risk money you can afford to lose.
Penny stocks in pop culture
In the movie “The Wolf of Wall Street,” penny stocks were the primary vehicle used to scam investors. The movie may be a fictionalized account, but it’s worth noting that penny stocks are ripe for scams and pump-and-dump schemes. Penny stocks often operate in the shadows of the financial markets, with little oversight or regulation.
Pump and dump schemes
While the term “pump and dump” is most often associated with cryptocurrency markets these days, this type of scam has been around for a very long time. Because penny stocks have a small market cap and below-average trading volume, their prices can be easier to manipulate, making penny stocks prime targets for “pump and dump” scams.
A “pump and dump” occurs when early investors acquire a large stake in a stock and then create hype to drive up the price. When prices reach unsustainable levels, the insiders begin dumping shares on the unsuspecting public, causing prices to fall precipitously. Everyone but the insiders then face substantial losses, and some may even be left with worthless shares.
Securities laws make “pump and dump” schemes illegal in the U.S., EU, and elsewhere – but that doesn’t stop scammers from trying.
Remember:
Even if a certain penny stock isn’t the target of a pump-and-dump scheme, the volatility and lack of liquidity can create conditions that result in huge swings and plummets in value. A penny stock can cause significant losses even if it’s not being pumped and dumped.
Final thoughts
Penny stocks can be enticing due to their potential to deliver unreal returns, but they come with significant risks that make them unsuitable for many investors. While some traders may find succeed with careful research and strict risk management, their low liquidity, lack of transparency, and susceptibility to fraud make penny stocks a high-stakes gamble. For most, the volatility and uncertainty outweigh the rewards.
If you decide to invest in penny stocks, approach them with caution. It’s a good practice to set realistic expectations and only invest money you’re willing to lose. For those who prefer a steadier path to building wealth, more traditional investments (like stocks, ETFs, and bonds) may be a better fit.
Passive investing
Less prone to dramatic gains (or losses), passive investing is a great way to grow wealth on a longer timescale. For more details, check out our full how-to guide on passive investing strategies.
FAQs
Where can I buy penny stocks?
By and large, you can buy penny stocks at many of the best stock brokers. If you want a more in-depth look at stock brokers that offer the ability to buy and trade penny stocks, check out our guide to the best brokers for penny stock trading.
Are penny stocks a good investment for beginners?
In general, newer investors ought to shy away from penny stocks. The risks are simply too great. While penny stocks can be profitable when picked correctly, they can also fall rapidly or even go to zero. A safer option for beginners looking to invest with small amounts of capital would be to buy fractional shares of large-cap companies. Check out our guide to the best brokers for fractional shares.
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About the Editorial Team
Brian Nibley is a copywriter and journalist who has been writing about fintech and finance-related topics since 2017. His work has appeared in publications such as MSN Money, Business Insider, Cointelegraph, BitPay, and Finance Magnates.
Joey Shadeck is the Content Strategist and Research Analyst for StockBrokers.com. He holds dual degrees in Finance and Marketing from Oakland University, and has been an active trader and investor for close to 10 years. An industry veteran, Joey obtains and verifies data, conducts research, and analyzes and validates our content.
John Bringans is the Managing Editor of StockBrokers.com. An experienced media professional, John has a decade of editorial experience with a background that includes key leadership roles at global newsroom outlets. He holds a Bachelor’s Degree in English Literature from San Francisco State University, and conducts research on forex and the financial services industry while assisting in the production of content.