Investing in penny stocks allows traders to rapidly increase their profits, but it also allows them to lose their trading capital quickly. These five tips can help you mitigate the risks connected with one of the riskiest investment vehicles.
1. There’s a reason penny stocks are just that: they’re a penny.
While we all dream we could invest in the next Microsoft or Home Depot, the chances of you discovering that once-in-a-decade success storey are slim to none. These businesses are either just getting started and purchased a shell company to save money on an IPO, or they lack a compelling business model to justify investment banker money for an IPO. This isn’t to imply they’re a bad investment, but it should make you reconsider the type of company you’re putting your money into.
2. Trading Volumes
Look for a large number of shares that are traded on a regular basis. The average volume can easily mislead you. If ABC trades 1 million shares today and does not trade for the rest of the week, the daily average will be 200,000 shares. To go in and out at a respectable rate of return, you need a consistent volume. Take into account the number of sales per day as well. Is there a single insider who is buying or selling? The first thing to think about is liquidity. If there isn’t enough volume, you’ll have “dead money,” where the only option to sell shares is to dump at the bid, increasing selling pressure and driving the sale price even lower.
3. Is the company able to turn a profit?
While it’s not unusual for a company to lose money, it’s vital to figure out why. Is it feasible to deal with it? Will they have to hunt for further capital (dilution of your equity) or a joint venture that benefits the other company?
If your company knows how to make a profit, it may put that money to good use by expanding its operations and improving shareholder value. You’ll need to do some research to find these businesses, but once you do, you’ll lower your odds of losing money while increasing your possibilities of generating a much larger return.
Penny stocks have a high degree of volatility. They’ll be whizzing up and down at incredible speed. Keep in mind that if you buy a stock for $0.10 and sell it for $0.12, you’ve made a 20% profit. If the price lowers by 2 cents, you will lose 20% of your investment. Several equities trade in this area on a daily basis. A 20% loss on your $10,000 investment capital equals a $2000 loss. You will run out of money if you repeat this five times. Keep a tight eye on what’s going on around you. If you’re stopped out, move on to the next opportunity. The market is trying to tell you something, and it’s usually best to listen whether you like it or not.
If you expected to sell at $0.12 but it increases to $0.13, you have the option of accepting the 30% profit or setting your stop at $0.12. Keep your gains while expanding your upside potential.
5. How did you find out about the stock?
A mailing list is where the bulk of people discover about penny stocks. There are many reputable penny stock newsletters available, but there are also many people who are pushing and dumping. They’ll buy a lot of shares, along with insiders, and then sell it to unsuspecting newsletter subscribers. Subscribers are buying while insiders are selling. Here’s a hint: it’s not you.
Not all newsletters are worthless. I’ve seen my fair share of dodgy firms and promoters after working in the industry for the past eight years. Some are compensated in stock, some in restricted stock (stock that cannot be sold for a certain period of time), while still others are compensated in cash.
What criteria do you use to determine which companies are good and which are bad? Sign up for a free account and keep track of your investments. Was there any way to earn money that was legal? Do they have a history of providing amazing opportunities to their subscribers? You’ll be able to tell right away if you’ve signed up for a good newsletter.
Another piece of advice I would give you is to not put more than 20% of your portfolio in penny stocks. You’re investing in order to make money and save money for a more difficult time in the future. By placing too much money at danger, you increase your chances of losing it. If that 20% grows, you’ll have more than enough money to earn a respectable rate of return. Why would you want to invest more in penny stocks and risk your money?
