Despite their inherently risky nature, you can make money in penny stocks. Like investing in any asset class, investors can take simple steps to minimize risk.
Limit Exposure - Most experts say an investor’s exposure to penny stocks should be no more than 5-10 percent of their portfolio. These same experts suggest, as a best practice, they limit their exposure to any individual penny stock to 1 or 2 percent of your portfolio. This reinforces a fundamental point that investors shouldn’t invest any more money in an asset class than they are comfortable losing.
Think of Penny Stocks as Short-Term Investments – If an investor profits off of a penny stock, they should look to sell and invest that money into their long-term investments. This will help to avoid losses and keep their exposure to penny stocks at a comfortable level.
Buy Penny Stocks With High Liquidity – This helps to ensure that investors can easily trade these stocks. One way to do this is to look at the average daily trading volume. Since it’s possible to own a large number of shares, it’s important to pick stocks that allow investors to sell a large number of these shares if necessary. In some cases, if the volume of a stock is only 1,500 shares a day and an investor owns over 15,000 shares, that means there aren’t enough buyers to get out of a position quickly.
Avoid Special Fees or Volume Restrictions - Since investors will be looking to trade these stocks rather quickly, they should use a trading platform that is not going to charge special fees or put in volume restrictions. Essentially, investors need to be able to trade these stocks just like any other common stock.
Trade a Watch List Before Committing Real Dollars - An old-school tip that can help investors decide if a stock is worth your risk, particular for beginners, is to consider paper trading. This is a very simple concept where investors invest an imaginary amount of money and then track your trades without exposing actual money. This helps investors see how quickly a stock is moving and how much volume is changing hands. Many investment platforms make it easy to track your watch list.
Perform Due Diligence - It may be tempting to invest in the latest “hot stock or industry”. The penny stock industry is littered with companies that advertise the potential to make money in oil, gas, gold and other precious metals. However, if information about a company is not readily available, or if a company seems reluctant to provide that information, then it’s a sign to look for another investment.
Another good mantra to remember with penny stocks is to focus on companies where you may have some interest and/or expertise. After all, if you are a programmer, you will be much more likely to separate a tech guru’s hype from real innovation.
There are many good stock screening services available to help you find potential penny stock companies. This should not be the extent of your research, but it could help you create a quick short list in an industry that you can then individually research. Considering there are, literally hundreds of penny stock companies, having a tool that can help you uncover potential candidates can help focus your efforts.