Reduce Your Risk When Trading Penny Stocks

It’s well established that penny stocks carry a higher than normal risk when it comes to investments. This doesn’t mean that penny stocks shouldn’t be a part of your portfolio though. Micro cap stocks have the potential for huge gains if you can work past the scams and bankruptcies. If you want to know how to reduce your risk when trading penny stocks here are a few tactics you may want to use to lower your overall risk and create a diversified growth area for your stock portfolio.

Find Micro Caps on Major Exchanges

Not all micro caps are in the pink sheets or OTC exchanges. Some companies hit hard times and their price falls into penny stock categories.

One example of this a few years ago was Citi Corp (Stock Ticker: C). The price was below $5 per share, but the company was valued at nearly 75 billion dollars. The average volume on this stock was nearly 700 million shares a day.

There is no organized unit (other than the federal government) who has the power or money to manipulate the price of this stock. The volume alone allows the market markers to keep the spread very low and there is always a buyer or seller available. The price in the market is never an estimate like it is in the pink sheets.

Use Stop Losses and Limit Orders

Stop losses and limit orders are always good practices for all stock trading. (You are using them aren’t you?) In penny stocks they are even more important. Any time you invest in any stock you should know what you think the stock is worth. If you don’t have a personal feel for this by using some valuation tool then you are gambling. Put a limit order of the maximum you are willing to pay for the stock when you place your order. Penny stocks are so volatile and the spread is so wide that you may end up paying much more than you planned with a market order. This is not a good start with a high risk investment.

Before you purchase the stock you need to know when you are cutting your losses. Therefore you must set a stop loss when you make your purchase. This will help prevent you from losing all of your investment in a penny stock death spiral. Keep in mind you still need to keep an eye on the news of a stock and sell before your stop loss if you are concerned, because if the stock falls quickly with zero buyers the price will bypass your stop loss. A stop loss is not an insurance plan from your stock broker just a tool to assist you.

Know When To Take Profits

A good tool used by professional gamblers is to take profits off the table. When you get a successful penny stock human greed often takes over and you want the huge gains to continue. Then bad news comes out about the stock (either a penny stock scam, or fraud, or competition moves into the industry) and the stock plummets again wiping out your paper gains.

Create a plan to collect your earnings while a stock is rising, but one that also leaves something on the table to enjoy the momentum. You can either sell a percentage of your stock as the price rises or keep moving your stop loss up as the price rises. Be careful, if you move your stop loss too close to the top of the rise you may whipsaw yourself out of a great position.

The key to keeping your risk low in penny stocks is maintaining a level head. Don’t get caught up in hype or dreams of riches and simply use the small companies as another weapon in your investing arsenal.