In the ever-evolving landscape of financial markets, two investment avenues stand out for their potential to deliver substantial returns—penny stocks vs forex trading. Both offer unique opportunities and come with their own set of risks, but understanding their fundamental differences can be key to aligning them with your investment strategy.
Whether you’re drawn to the low entry cost and speculative nature of penny stocks or the fast-paced, global scale of forex trading, it’s essential to grasp the nuances of each before diving in. In this article, we’ll explore the core characteristics, potential benefits, and inherent risks associated with penny stocks and forex, helping you make an informed decision about which path might be right for your investment goals.
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What Are Penny Stocks?
Penny stocks typically trade for under $5 per share. Most penny stock companies are companies that haven’t achieved much notoriety and traditionally have small market capitalization.
Those two factors make them highly speculative, which equals high risk for traders. Penny stocks are quoted over-the-counter, such as on the OTC Bulletin Board or “pink sheets” and can also trade on securities exchanges, including foreign securities exchanges.
How to Invest in Penny Stocks
If you’ve decided you’re game to try penny stocking despite its highly speculative nature, do your research of the penny stock companies you’re interested in, then:
- Choose a stock broker to open an account with.
- Determine which stock to trade; a good starting point is to use tools from the OTC Markets website or Finviz. The OTC Markets Group also organizes securities into tiered marketplaces that can help you determine which stocks to trade.
- Start by paper trading for a reasonable amount of time so you gradually build more confidence with real money.
- Begin trading, but be sure you’re comfortable with losing money on some (or potentially all) of your trades, particularly when trading on margin.
- Get a mentor who trades penny stocks.
What is Forex?
The market participants in a forex market include traders, investors, governments, banks, businesses and more. The market is open 24 hours, five days a week. When you trade forex, you simultaneously buy and sell currency pairs. The most often-traded currency pairs include:
- EUR/USD: The euro and the U.S. dollar
- USD/JPY: The U.S. dollar and the Japanese yen
- GBP/USD: The British pound sterling and the U.S. dollar
- USD/CHF: The U.S. dollar and the Swiss franc
Notice that all pairs include the U.S. dollar. (If you don’t see USD on the list, it’s not a major currency pair, and is instead called a currency cross.) Examples of these can include, but are not limited to, euro crosses and Japanese yen crosses:
When trading forex, you sell one currency (the base currency) in order to purchase another (called the quote currency). The base currency and the quote currency are both always in flux. The exchange rate shows how much you’ll pay in units of the quote currency to buy one unit of the base currency. When you sell, the exchange rate reflects the number of units of the quote currency you will receive for selling one unit of the base currency. Here are a few other terms to know:
- Going long: You buy the base currency and sell the quote currency.
- Going short: You sell the base currency and buy the quote currency.
- Bid-ask spread: The difference between the price at which a dealer will buy and sell a currency.
- Bid price: The amount of money a dealer is willing to pay, or “bid” for a currency.
- Ask price: The amount of money a dealer wants for a currency.
- Price interest point (pip): The measure of the movement in the exchange rate in a currency pair.
Costs of Penny Stocks and Forex
In order to trade forex, you’ll need to open a trading account with a forex broker. Similarly, penny stocks don’t require any set fees, trading costs or account minimums. There are no rules about how much a broker can charge you, so it’s important to shop around and compare amounts and services.
Regarding forex, some firms charge a per trade commission, while other firms make their money on the spread between the bid and ask prices. Note that some forex firms advertise “commission-free” trades, but understand that through the bid/ask spread, they’re still making money off your trades.
Here’s a quick example from TD Ameritrade listing the fees involved, and it’s a great example of how to search costs:
How to Choose a Forex Broker
Choosing a broker can be such a personal decision; it doesn’t really matter which one your friend uses or even a certain professional trader uses. If a particular broker works best for you, then go with it!
A broker should provide you with extensive research and analysis, competitive trade prices and educational material, including a practice account that helps you learn the ropes.
Last but not least, it’s important to have a top-notch trading platform with a full suite of tools (that you’re comfortable using, of course).
Final Thoughts on Penny Stocks vs Forex
As you can see, penny stocks and forex have hardly anything in common. However, they’re both risky in their own very specific ways. The penny stock market is risky because it’s highly speculative, as mentioned above. On the other hand, the forex market is risky because of the amount of leverage potentially involved. You’re typically required to put up just 1% in margin of the total value of a forex contract.
Frequently Asked Questions
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Choosing between trading stocks and forex depends on whether you seek the long-term growth and stability of stocks or the high liquidity and short-term opportunities of forex, with each offering distinct risks and rewards.
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Yes, day traders often use penny stocks due to their low prices and high volatility, which can create opportunities for quick profits, though these stocks can also carry significant risks.
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Forex trading can be less risky than stocks in terms of lower entry costs and high liquidity, but it also involves significant risks due to its high volatility and leverage, making it crucial to understand both markets before investing.
