Penny stocks are an inexpensive way to diversify your investments and could multiply over time. But they’re also very risky investments because the companies are usually small, unestablished and fighting an uphill battle competing against other companies in their market. And yet, who doesn’t like an underdog?

What are penny stocks?

Penny stocks is a loose name for cheap, low-priced shares of small, often newly listed companies. Investors are often attracted to penny stocks for their cheap prices and potential growth opportunities, though there are risks involved with penny stocks, too.

In the UK, penny stocks are generally defined as those that either trade below £1 per share or have a total market cap that’s less than £100m.

Can you trade penny stocks in the UK?

Yes, you can buy and sell penny stocks in the UK, and most can be found on the FTSE AIM index, which consists of all companies quoted on the London Stock Exchange under the Alternative Investment Market (AIM). This is where smaller companies can float their shares and is therefore where you can find most UK penny stocks.

How to buy penny stocks in the UK

  1. Choose a share trading platform. If you’re a beginner, our table below can help you choose.
  2. Open your account. You’ll need to verify your identity when you sign up.
  3. Fund your account. You’ll typically be able to use a bank transfer to send money to your trading account.
  4. Find the shares you want to buy. Search the platform for the shares you want and then click “Buy”.

Compare share trading platforms

Table: sorted by promoted deals first

All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.

What defines a penny stock?

There is no official definition of penny stocks in the UK, but some of the typical characteristics of a penny stock include:

  • Small company
  • Market cap below £100m
  • Newer company recently listed
  • Share price below £1
  • Limited financial track record
  • Doesn’t pay dividends

Penny stocks vs blue chip stocks

On the opposite side of the scale to penny stocks are blue chip stocks. In comparison to penny stocks, blue chip stocks are large listed companies that have been around for a long time and have a long, stable financial track record.

While penny stocks in most cases pay no dividends, blue chips stocks almost always do.

Should you invest in penny stocks?

You could consider investing in penny stocks if:

  • You have a high risk tolerance
  • You’re an experienced investor
  • You’re willing to cut your losses if the share price falls significantly
  • You have a long investment time frame and are willing to ride out the volatility
  • You’re happy to take a bit of a “gamble”

Tips for buying penny stocks

Do your research

This is important for all investments, but particularly higher-risk investments like penny stocks. Blue chip stocks are, by their nature, lower-risk options as they’ve got a long history of strong financial performance.

Plan a strategy and stick to it

Before you start buying, decide which penny stocks you’re going to invest in and how much you’re going to invest in each one. It’s also important to decide what price you’d sell at if the shares were to fall and stick to it to avoid the “I’ll just hold a little longer and see if the price jumps back up” mentality. The same applies for gains.

Don’t make emotional decisions

It can be easy to get emotionally attached to a penny stock, as they’re often the underdogs in your portfolio. So when their share price falls and falls some more, you can find yourself making excuses as to why you should keep holding. This is why it’s important to make a strategy, so you leave the emotions out of it.

Don’t get sucked in by the “cheap” prices

Penny stocks may appear to be cheap in comparison to other shares listed on the LSE, but don’t base your investment decision purely on this. One factor that influences a company’s share price is the demand for its shares. The less demand from investors, the lower the share price. So some penny stocks may appear to be cheap, but you need to ask yourself why this is.

Pros and cons of penny stocks

Here are some of the benefits and risks of investing in small-cap UK penny stocks:

Pros

  • Low prices. Because they’re low priced, investors can hold a diversified portfolio of penny stock companies without needing to spend as much as they typically would.
  • Growth opportunity. Small-cap, newly listed companies can often present great growth opportunities if you pick the right ones. However, it could be a bumpy ride to the top.
  • Thrilling. Penny stocks often see their share prices change significantly in little time, which can be exciting and thrilling for investors with a high risk tolerance.
  • Day trading. Because of their large price swings, penny stocks are often used by active day traders.

Cons

  • High-risk. Penny stocks are very high-risk investments compared to other listed companies and ETFs with a longer financial track record. Not all companies that list on an exchange do well and a lot of penny stocks never become anything more than a penny stock.
  • Very volatile. Penny stocks often experience extreme share price highs and lows within a matter of days (or even within the same day).
  • No income. Penny stocks rarely pay any dividends, as all revenue is usually reinvested back into the company to help it grow.

Bottom line

Penny stocks can be a nice addition to your investment portfolio, they’re low cost which means you can buy a lot of shares for a small amount of money – but they can be riskier. Remember that you still need to diversify your portfolio and that you should only invest money that you’re prepared to lose.

As always, do your research. Are these stocks truly undervalued, is there a good reason to believe they’ll rise in the future or are they cheap for a reason?

All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.

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