Penny Stocks in Trading: What Are They and Should You Trade Them?

One of the reasons these shares aren’t listed in the major exchanges is that the companies these shares belong to are either too small or too early in their journey to be able to comply with the strict regulations required by traditional exchanges.

That doesn’t mean that never happens though. As of the time of writing in February 2025, there are penny stocks trading on NASDAQ today, like ATAI Life Sciences N.V. (ATAI), with a price of $1.50 and BTCS Inc. (BTCS), at $3.09.

It’s also really interesting to remember that famous companies like Apple and Amazon also had their penny stock days before growing into the empires they are today. But of course, for every penny stock that succeeded, many have also failed.

How penny stocks work

Penny stocks can be bought and sold through brokerage platforms that have access to OTC Markets Group.

A key factor to consider is the costs associated with each brokerage. Because penny stocks have low prices, the transaction fees could add up pretty quickly. A popular option is to seek platforms that have flat fees for certain types and quantities of stocks.

Also, penny stocks have lower trading volume than common stocks, which means it could be a while before you’re able to sell your stocks if you decide to do so.

This problem of lower liquidity is one of the major factors to consider when thinking about the risks associated with penny stocks. Since it’s probably going to be harder to sell the stocks at the desired price, investors face more risks of being stuck with shares they can’t sell.

Sometimes, these price variations can be linked more to hype in investment communities than to the actual growth of the companies. People spread all kinds of information online, purporting to have an “insider” take, but more often than not these takes can’t be backed up by actual financial information.

Why do investors trade penny stocks?

Despite its risks, penny stocks have their place in the strategy of many investors. Below are the main reasons people choose these types of shares:

1. Potential to generate big returns. Penny stocks can have drastic price changes in short periods of time, so it’s possible that investors who open their positions at the right time can enjoy massive gains.

2. Low cost to buy. Since they typically cost under $5, investors can buy multiple shares with a smaller investment. It’s different from traditional stocks that can cost hundreds or thousands of dollars.

3. Good for short-term strategies. Those who enjoy day trading or swing trading can benefit from the volatility of penny stocks, gaining significant profits in a matter of days or weeks.

4. Hype and excitement. Many investors get excited with the idea of finding the next big thing, a “hidden” gem that will grow quickly. Social media and online communities about investments can hype up certain companies and shares.

5. Portfolio diversification. Certain investors like to apply a smaller part of their investment budget to high-risk investments, such as penny stocks. This way they can benefit both from steady growth and higher returns.

In summary, there are many reasons penny stocks can be a good addition to an investment portfolio. However, as you’ll see below, they also have considerable risks, including the possibility of scams and fraud.

Risks of trading penny stocks

This type of low-priced share can offer bigger returns compared to its normal-priced counterparts, but the risks are also in equal measure. Listed below are the main threats related to trading penny stocks:

1. Extreme volatility. Penny stocks can double their value in hours, but they can also completely lose their value overnight. These rapid price changes can be good for experienced short-term investors, but they can also mean huge losses.

2. Low liquidity. Since many penny stocks have low trading volume, it can be hard to sell the shares once you believe it is a good time to do so. Investors may find it difficult to sell at the desired price and may have to compromise.

3. Exaggerated hype. Sometimes the price of a penny stock will be more related to the excitement around the company than its actual growth or products. Investors need to be careful about unofficial news and recommendations, especially online.

4. More possibility of scams. With less regulation, penny stocks are more susceptible to fraud and manipulation. People can artificially increase the prices to try selling at the top and leave others with worthless shares.

5. Less transparency and data. Since many penny stocks don’t have to adhere to strict regulations and transparency requirements, it’s harder for investors to get reliable information about the financial status of the companies.

Penny stocks vs. blue chips

Blue chips is a common financial term that refers to the stocks of well-known, well-established companies.

In many aspects, they are the exact opposite of penny stocks: reliable, with steady growth over time, and lots of financial data to back everything up.

Companies like Microsoft, Apple, and Amazon are considered blue chips. They are leaders in their respective markets and investors can access all of their trusted information easily.

Check out the table below for a side-by-side comparison:

Also, it’s entirely possible to spread your budget and mix those investments. Many investors allocate the majority of their budget to safer choices but reserve a small part of it for high-risk and high-reward assets.

How to invest in penny stocks safely

Penny stocks are risky and volatile, but if you do decide to invest in them, there are some important precautions you can take to minimize your risks and enjoy the benefits of high growth potential.

Be aware of these steps before investing in penny stocks:

1. Do your own research. Be critical of information you find randomly and always make sure to do your homework about the financials of companies, management teams, industry trends, and claimed profits.

2. Choose the right platform. Not every brokerage firm allows the trading of penny stocks. Make sure to choose a reputable one that does and also check their fees, because generally, OTC transactions can be more costly.

3. Take care of proper risk management. Since penny stocks move so quickly, sometimes in minutes or hours, be sure to use stop-losses to sell your shares automatically if the price drops too much unexpectedly.

4. Be careful with hype. Overhyped companies and “hot stock tips” can be scams. Don’t blindly trust in tips you find online about profitable stocks, and be skeptical about promises of huge profits and guaranteed gains.

5. Use money you can afford to lose. A typical strategy is to use only 5% of your budget in high-risk assets like penny stocks. Be prepared to lose that money if things go wrong and complement your portfolio with safer investments.

Nothing is ever guaranteed, especially with penny stocks. With the precautions above, you’ll be able to invest in a safer and more manageable way.

Should you consider trading penny stocks?

The answer to that question depends entirely on your financial goals and personality as an investor.

Penny stocks are usually a better option for experienced traders who have a high tolerance for risks. If you enjoy a more hands-on approach and wish to capitalize on short-term market movements, then they could be a nice addition to your portfolio.

If you are more keen on a buy-and-hold approach and don’t want to deal with the worries associated with high-risk investments, maybe you should consider safer choices like index funds and blue chip stocks.

On the same note, investors who are more focused on retirement and long-term returns probably won’t benefit much from penny stocks.

Penny stock regulations

As mentioned, penny stocks are highly speculative investments that operate with less transparency and provisions of information.

However, institutions like the U.S. Securities and Exchange Commission (SEC) and FINRA (Financial Industry Regulatory Authority) have measures to regulate the trading of penny stocks as much as possible.

For example, the SEC regulates penny stocks that are traded on major exchanges and also on some OTC markets, requiring that companies fill out forms about their financial situation. The Securities Exchange Act of 1934 also requires that businesses file periodic reports to prevent fraud and misrepresentation.

Unfortunately, even with those measures, penny stocks are still a vulnerable environment susceptible to scams and fraud. Investors with bad faith can overhype some assets online to be able to sell them at the highest price possible, doing what is known as a pump-and-dump scam.

Make sure you keep a close eye on the financial reports of companies you wish to invest in, be careful with online hype, and remember those factors to minimize your risk and chance of falling prey to a fraudulent scheme.

Famous fraud cases involving penny stocks

The story of Jordan Belfort, eternalized in the famous movie The Wolf of Wall Street, is a cautionary tale about the dangers of penny stocks. He used to pump the value of penny stocks of companies he owned, allowing him to sell them later at a higher profit, doing a textbook pump-and-dump scheme.

Another famous case is the story of Zirk de Maison, an American who created shell companies and inflated their prices by pressuring investors to buy their stocks. He told people the companies were involved in copper and gold mining, among other businesses, but in reality, they did nothing and had zero assets.

Because it’s hard to find information about specific penny stocks and the businesses they belong to, stories like that are unfortunately common in the penny stocks world. Keep that in mind on your investment journey and make sure to research properly before investing in anything.

Summary

Penny stocks are low-priced securities usually traded for less than $5. While they can be a legitimate way for smaller emerging companies to raise some capital, investors should be aware that they are highly speculative and volatile investments.

Because of less regulation and risk of fraud, it’s important to analyze if they fit into your macro financial goals and if you’re prepared to deal with their rapid changes. If you do decide to invest in penny stocks, always do your own research and consider combining them with safer investments.