The following 17 tips apply to all stock market investing, but they were honed and learned from the chaotic world of tiny—penny stock—shares. There are lessons to be learned from a 20 cent or $2 investment which could never be taught by purchasing a share of IBM or GM.
If you want to become an incredible investor, you need to be right in the middle of the action. There is no better place to hone your skills, learn rapidly, and constantly adapt than among the highly-volatile, quickly moving world of the smallest among investments.
Apply the wisdom of these 17 thoughts to your own trading style, no matter what type of company or price of shares you may be buying or selling.
- Investing in low-priced stocks isn’t for everyone, but all investors can learn from the lessons of penny stock trading.
- Lessons include cut losses early, let gains run, don’t put more cash into a falling stock, and put more funds into a winning investment.
- Try paper trading, which is keeping track of stocks you would have bought, before you buy penny stocks with real money.
- If you do invest in penny stocks, make sure you only use money that you can afford to lose.
1. Cut Losses Early
When shares start going the wrong way, take the pain and rip it off in one motion like a bandaid. Of course, every investment will wobble a tiny bit in value, but if the stock falls through your pre-determined loss-limit, it's possibly time to take the hit and move on.
Often the shares will just keep sinking, making the early exciters look pretty smart. This also opens up the opportunity to buy back in at much lower levels in the near future.
2. Let Gains Run
Lots of stocks start moving in the right direction, and they just keep climbing. Typically the shares reach well beyond what most investors might expect.
Some of America's greatest companies started as penny stocks, and now trade for $10, $20, or even $50 per share. If the business continues to grow, savvy investors hold on for the ride. Meanwhile, many others sell far too soon, gloating about their 100% gain, then crying as the shapes reach for the stars.
To avoid selling too soon, constantly re-assess the underlying company. If they are enjoying rising market share, revenues, and customer levels, you may want to hold long term.
3. Don't Average Down
Most investors try to make up for their mistakes by putting more cash into a falling stock. For example, if the shares drop 30% or 50% or 88% in value after their original purchase, they buy even more of the stock. This makes their average price per share lower.
There are problems with this tactic. First of all, the investor was wrong about the shares in the first place. Also, the investment is probably falling for a reason, and in most cases has plenty more downside to go. As well, the investor has just put more of their (probably) small portfolio on the line in shares which are trending lower!
4. Average Up
In contrast to averaging down, averaging up is often a more effective strategy. If an investor makes a purchase and the shares start climbing, they have been proven right about their trade. The shares are going higher, and, usually, an uptrend will be sustained if the underlying company is doing well. Putting more funds into a winning investment often pays off very well.
5. Paper Trade
So many people want to jump into penny stocks but aren't sure how to begin. They are also cautious of the risks or don't understand the process of buying and selling.
Paper Trading is the answer. Simply keep track of stocks you would have bought, but doing this with imaginary money. Paper Trading will make all the difference in your trading results and stock market understanding. No risk, no money required!
6. The Single Biggest Investor Risk
We dedicated an entire article to Confirmation Bias, which absolutely is the single biggest risk to any and all investors. Learn about it before you trade another share of stock!
7. Don't Trust Free
Free stock picks, especially in the world of penny stocks, are absolutely dangerous! Hidden motivations meet greed when these dishonest promoters try to trick masses of people into buying shares of their latest worthless company.
That's why their communications are always free, whether they are sowing seeds through the rumor mill, sending unsolicited faxes, or dumping dishonesty on you through free online newsletters.
8. Don't Follow Advice from Friends...Unless They Are Doing Better Than You
Why would you trust a life coach who is unhappy? Why learn from a Jiu-Jitsu instructor who has lost every fight? Listen to the people around you who do well with their investments, and ignore everyone else.
9. Mandatory: Due Diligence
You shouldn't bet big on a casino game you don't understand. Likewise, if you invest in any shares, and especially if they are volatile, small, risky penny stocks, it is paramount to know where you are putting your money.
There are a lot of facets to any company and spending a little bit of time will ensure that you don't get surprised by anything.
10. Buy What You Know
Too many investors buy shares in businesses that they absolutely do not understand. Forget the hot "nano-surgery neuro-electrode company," focus on stocks you understand. If you know how they make their money, what they are hoping to do, and where the industry is headed, you will have an advantage over other investors.
11. Stick to the Good Markets
Especially with penny stocks, there are some pretty awful marketplaces that are saturated with low-quality companies. Buying companies on the OTCQX or Pink Sheets puts you at a disadvantage since you will be surrounded by many ill-advised investment choices. The odds are heavily stacked against any investor buying shares from these lowest caliber exchanges.
12. Keep Doing What Works, Stop Doing What Doesn't
Whatever you are investing in, and however you are doing it, you should double down on the successful tactics, while scaling back the losing strategies.
If you make money on mining penny stocks every time, while losing on Exchange Traded Funds (ETFs) for example, it's probably time to adjust your strategy towards your winners.
13. Be Wary of Media
Mainly, the "news" is not reporting what WILL happen, nor are they even telling you what IS happening. Media reports are typically talking about what has ALREADY happened.
They do a great job of making the information seem current or relevant in the exact moment, but by watching from a different angle, you will start to see which events are about to die away, and thus your investment decisions will improve.
For example, the media talked the most about Dot Com stocks just as the bubble burst. The biggest news channels followed Occupy Wall Street the most as the movement passed its peak. There was maximum coverage about pot penny stocks immediately before the industry plummeted. In any event, the news is telling you what has ALREADY been significant, not what IS going on.
14. Don't Buy What Everyone Else Is Buying
The act of mob-mentality buying means the investment is overvalued. Whether pot penny stocks, Bitcoin-related businesses, companies from the Dot Com mania, or Dutch Tulip Bulbs, you will never get a fair price.
Another unfortunate side of this equation is that when the majority are hearing about the latest craze and jumping on board, the stampede is just about to come to an end. Fortunes will be invested and lost within weeks, if not days.
15. Call the Company
This is the top method to perform some great due diligence and learn all about the investment and their prospects. Every publicly-traded stock on the market has an Investor Relations contact, and they will be more than happy to answer all of your questions. It's free, and very well might help you understand whether or not your investment is going to be profitable.
16. Be Honest With Yourself
Maybe penny stocks and investing just aren't right for you. That's OK, spend your time and money doing something else you like better. If you do invest, make sure you really are using risk money, so that if the shares you bought start going the wrong way, you'll still be able to pay your rent.
17. There Is No Investing Magic Bullet
Too often investors keep hopping from one concept to the next, usually never making money in any of them. If the "robot that picks stocks (scam)" didn't work, maybe they switch to trading options. When that doesn't work, their next step might be short selling. That doesn't work, so they try binary options...derivatives... foreign exchange... commodities... The list will be endless.
Pay attention to these 17 tips for investors. They will get you trading stocks well in short order.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.