Penny stock trading is the highly volatile, short-term practice of investing in stocks usually priced around a penny (or just a few pence) a share. Since the coronavirus pandemic caused the March market crash and subsequent lockdown, penny stock trading is gaining popularity. People have time on their hands and without sports to gamble on, penny stocks look appealing. These share prices fluctuate rapidly, which means a lot of money can be made or lost in a brief space of time. The potential gains pull in investors, but the losses can be brutal.
Fear of missing out (FOMO)?
Along with the promise of potential gains, fear of missing out is often what drives investors into trading penny shares. UK Oil and Gas (UKOG) is an example of a widely traded stock that has plummeted this year. UKOG has been hyped and sold and bumped and boosted for years. But apart from an exciting period in 2017 when its share price almost hit 9p, it has otherwise barely been above 2p in the past five years. UKOG is a perfect example of the pitfalls of penny stock trading. The share price has fallen 78% year-to-date from 0.85p to 0.18p today. During this time, many holders of this share have lost money repeatedly.
There are some shares in the FTSE All-share index that may be confused as penny shares because their share prices are so low. These bigger companies don’t fit the classic categorisation of penny stocks but still qualify for the ‘dirt-cheap bargain’ description that drives so many investors into penny stocks.
For example, Tullow Oil shares have been languishing around 30p for a few weeks. It is up 37% in the past three months but still has many hurdles to cross. Stocks like Tullow, Premier Oil, EnQuest, and Lloyds Bank are all risky buys. But these are established companies with track records and determination. They have a higher likelihood of surviving the coming year than many that have share prices in the 1p-10p region. I am not confident enough to buy shares in any of them. But some investors will deem them cheap and worth a long-term investment.
Avoid penny stock trading volatility
Understanding the business, the sector, and the world it operates in is key to making sensible investment decisions. Investing off a hunch or because you like the sound of a company, is not a rational way to invest. Carrying out research, monitoring cash flow and income statements and reading a company’s annual returns are all vital if you intend to invest sizeable sums of money into a business. This is billionaire investor, Warren Buffett’s approach to stock market investing, and it is not as tiresome as it sounds. It does not take long to build up a clear picture of what you are getting yourself into with time spent reading and researching. Many successful investors have become ISA millionaires by following Buffett’s investment model.
Buffett chooses an established company that is struggling for reasons that can be overcome and shows clear potential for growth. This capacity for significant growth is the driving force of penny stock trading, but it is possible to buy lucrative growth stocks within a long-term investment portfolio, without resorting to the risk associated with penny stock trading.
Kirsteen has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.