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Penny stocks – Gambling or investing?

Penny stocks are stocks that are (usually) traded over-the-counter, and are valued at no more than $3-5 per share. The low price enables penny stock trading with less capital than traditional stocks, but it involves so many inherent risks, that many traders wonder if it is too much like gambling.

There are no absolute guarantees in any type of investment, so in a sense, every investment contains an element of gambling. This includes traditional stock market investments, real estate, even placing money in a savings account at your bank.

However, there are significant factors that draw a clear distinction when investing funds in stocks – whether on the stock market or OTC – and pure “gambling.”

Gambling relies on pure chance, and a gambler can do nothing that will affect the success of his bet. For example, when you toss the die, your chance of rolling a 3 is 1-6. After five rolls, if you still have not rolled a 3, the odds on your sixth roll is the same as it was on your first roll – 1 in 6. You cannot affect these odds.

However, when a person trades on penny stocks, while he cannot affect the direction the price moves, he can – and does determine how much to invest, when to invest and when to close the position. Proper analysis enables the trader to decide when to buy or sell, or whether to avoid the stock completely. The more control a trader has over his investment, the less it can be considered “gambling.”

Nevertheless, it is also important to realize that penny stocks are often far riskier than traditional stocks. They are more speculative than traditional stocks, and, because they are not traded on any of the major exchanges, they are not regulated, which makes them more susceptible to scams and frauds. Bid-ask spreads are usually larger with penny stocks, and price action tends to be more volatile.

So, while investing in penny stocks is not like visiting a Las Vegas casino, it often entails higher risks than cautious traders like. Many traders prefer trading foreign currencies, or forex (short for foreign exchange). Trading forex is more stable, and currencies are regulated by national banks. Furthermore, it is easier to apply solid technical and fundamental analysis based on known financial policies and world events to more accurately project how forex prices will move.

Traders who do not wish to actually purchase currencies and wait for the value to rise, opt instead to trade CFDs (Contracts for Difference). To trade CFDs, you determine whether the price of an asset will rise or fall. If you believe the price will rise, you take a “long” position, which is essentially “buying” it (without actually owning it). If the price rises, you “sell” back your investment and earn a profit on the difference. If the price falls, you either hold on to the position, hoping that it will eventually rise, or you minimize your loss by closing the position, and pay the difference.

Similarly, if you believe the price will drop, you take a “short” position, which means “selling” the currency. If and when the price does drop, you buy it back at the lower rate, and enjoy the profit.

One of the leading brokers for trading CFD's is Fortrade.com, which provides CFD trading on dozens of currency pairs, as well as stocks, indices, commodities, and more. The full list of Fortrade tradeable assets is here.

Whether trading on traditional stocks, penny stocks or CFDs, it is important to remember that, while it is not really like gambling, in the strict sense of the word, there are risks involved. There are no guarantees that markets will act and react as expected, and even the most experienced traders, can be, and often are mistaken in their analysis. It is possible to trade very successfully, but even then you will incur occasional losses and setbacks. Trade wisely, using all of the tools of analysis at your disposal. Trading is not a guessing game, and every successful trader must develop and find the trading strategy that works best for him.