Cheap stocks explained: how to trade penny stocks safely and profitably
Low-priced stocks, often trading below $5 per share, captivate traders with the allure of massive gains from small investments. But are these stocks undiscovered opportunities or dangerous gambles? This in-depth guide explores the realities of trading cheap stocks, including real-world examples, risk management strategies, and the best brokers to help you trade safely.
Potential rewards of penny stocks
1. High upside potential
Due to their low price point, even small upward movements in penny stocks can yield significant percentage returns. For example, a $1 stock that climbs to $2 represents a 100% gain, whereas a $100 stock would need to double to $200 for the same return.
➡ Notable examples:
- GameStop (GME) and AMC Entertainment (AMC) were once penny stocks before retail investor interest triggered historic short squeezes and substantial gains for early holders.
- Plug Power and Sirius XM also started as penny stocks and later evolved into large-cap companies.
2. Market inefficiencies and undervalued assets
Large institutional investors and hedge funds often avoid penny stocks due to low liquidity and compliance risks. This creates inefficiencies that retail traders with strong analytical skills can potentially exploit. A thorough review of a company’s business model, cash flow, debt structure, and industry position can sometimes reveal overlooked value.
3. Potential for business turnarounds
Some companies trading below $5 are not necessarily poor performers—they may be startups, recovering from a crisis, or in cyclical industries. A new product, regulatory approval, or leadership change can catalyze a rebound.
Key risks of investing in penny stocks
1. Lack of regulation and transparency
Many penny stocks trade on the OTC markets (like the Pink Sheets), which are not subject to the same reporting standards as major exchanges. This makes it harder for investors to access accurate financial information, increasing the risk of fraud or corporate mismanagement.
2. Low liquidity
Penny stocks often suffer from low daily trading volume. This leads to large bid-ask spreads, meaning you might end up buying high and selling low. Furthermore, unloading a large position quickly can be difficult without impacting the market price.
3. High volatility and pump-and-dump schemes
These stocks are vulnerable to manipulation. In a classic pump-and-dump, promoters inflate a stock’s price through false or misleading statements, only to sell off their holdings at the top, leaving retail investors with heavy losses.
4. Weak business fundamentals
Many low-priced stocks belong to companies with deteriorating financials—declining revenue, mounting debt, or no clear path to profitability. Unlike established companies, they often lack competitive advantages, diversified income streams, or sound governance structures.
How to trade low-priced stocks safely
1. Stick to major exchanges (avoid OTC markets)
- NYSE and NASDAQ-listed stocks have stricter regulations than OTC (over-the-counter) stocks.
- Example: Tesla (TSLA) was once a $3 stock (2010) but was listed on NASDAQ, unlike many OTC scams.
2. Check financials and news
-
Look for:
- Revenue growth (not just hype)
- Low debt levels
- Institutional ownership (hedge funds investing is a good sign)
-
Example: Plug Power (PLUG) was a penny stock in 2013 but grew due to hydrogen energy demand.
3. Use stop-losses and position sizing
- Never risk more than 1-2% of capital on a single trade.
- Set tight stop-losses (e.g., -10% to -15%) to avoid huge losses.
Check out: Forex risk management tools: automatic trading with popular market orders
4. Avoid FOMO (fear of missing out)
- Many traders lose money chasing “the next GameStop.”
- Example: Bed Bath & Beyond (BBBY) surged on hype but went bankrupt in 2023.
Red flags to watch for in penny stocks
❗ Avoid penny stocks that:
- Frequently issue new shares (diluting existing shareholders)
- Have no revenue but make extravagant future claims
- Appear in unsolicited emails or aggressive promotions
- Have anonymous or unverifiable leadership
Penny stocks can be hidden gems – but the odds are not in your favor without rigorous research, discipline, and risk control. For seasoned traders, they offer speculative opportunities with asymmetric risk-reward ratios. However, the dangers often outweigh the potential gains for beginners or long-term investors.
If you choose to explore this volatile space, treat it like venture capital: expect many losses but hope that one winner makes up for the rest.
Best Forex and CFD brokers for trading low-priced stocks
If you’re trading penny stocks, forex, or CFDs, choosing the right broker is crucial. Below are the five top brokers, analyzed in detail:
XTB
📌 Regulation: FCA (UK), CySEC (EU), KNF (Poland)
💰 Min. deposit: $0 (varies by region)
💵 Spreads: From 0.1 pips (EUR/USD)
📊 Platforms: xStation 5 (user-friendly), MetaTrader 4
🎯 Best for: Traders who want tight spreads and a professional platform.
✅ Pros:
- No commissions on stock trading (EU clients).
- Free access to market research and webinars.
eToro
📌 Regulation: FCA, CySEC, ASIC
💰 Min. deposit: $50 (varies by region)
💵 Spreads: Variable, starts at 1 pip (EUR/USD)
📊 Platform: Proprietary social trading platform
🎯 Best for: Beginners who want to copy successful traders.
✅ Pros:
- Copy top traders automatically.
- User-friendly mobile app.
Risk disclaimer: eToro is a multi-asset platform which offers both investing in stocks and cryptoassets, as well as trading CFDs.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 61% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
This communication is intended for information and educational purposes only and should not be considered investment advice or investment recommendation. Past performance is not an indication of future results.
Copy Trading does not amount to investment advice. The value of your investments may go up or down. Your capital is at risk.
Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment and you should not expect to be protected if something goes wrong. Take 2 mins to learn more.
eToro USA LLC does not offer CFDs and makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication, which has been prepared by our partner utilizing publicly available non-entity specific information about eToro.
AvaTrade
📌 Regulation: Central Bank of Ireland, ASIC, FSCA
💰 Min. deposit: $100
💵 Spreads: From 0.9 pips (EUR/USD)
📊 Platforms: MetaTrader 4/5, AvaTradeGO, DupliTrade
🎯 Best for: Algorithmic traders and long-term investors.
✅ Pros:
- Supports Expert Advisors (EAs) for automated trading.
- Wide range of CFDs (stocks, forex, crypto).
Exness
📌 Regulation: FCA, CySEC, FSCA
💰 Min. deposit: $10
💵 Spreads: From 0.0 pips (Raw Spread account)
📊 Platforms: MetaTrader 4/5, Exness Terminal
🎯 Best for: Scalpers and high-frequency traders.
✅ Pros:
- Ultra-fast execution (0.1 ms average).
- No withdrawal fees.
BlackBull Markets
📌 Regulation: FMA (New Zealand), FSA (Seychelles)
💰 Min. deposit: $200
💵 Spreads: From 0.1 pips (ECN account)
📊 Platforms: MetaTrader 4, MetaTrader 5, TradingView
🎯 Best for: Professional traders needing deep liquidity.
✅ Pros:
- True ECN execution.
- Institutional-grade pricing.
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