Are Penny Stocks A Good Investment Decision?
In this article, I’m going to break down a few things. If you’re new to penny stocks, you’ll want to pay close attention. First, what are penny stocks, really? Penny stocks are shares of companies trading for less than $5.
But if you ask some traders, they may say that they’re stocks trading for less than $1. Whether you use the Securities & Exchange Commission’s definition (stocks under $5) or someone else’s, the same things hold.
They’re high-risk, they can be high-reward, and, believe it or not, there are ways to profit with them consistently. But I would forewarn you: don’t jump in head-first before learning the ropes. I don’t mean just understanding the definition of penny stocks but actually how to go about trading them. Also, understanding the risks involved can be paramount to a winning strategy.
With so much fervor in the stock market today, it’s important to learn how to day trade. At the very least, understand the basics of investing if you can’t sit at your screen all day. While most of these cheap stocks tended to spike and drop quickly, others actually go on to move consistently higher over time.
5 Rules Of Penny Stocks
For those who’re just getting started with penny stocks, welcome. You’re going to go through plenty of different emotions and develop plenty of other strategies during your trading career. But many things won’t change and if you feel like you’re veering off course, keep these 10 things in mind as you trade. They might help you focus or get re-focused on what matters most: making money with penny stocks.
Penny Stock Rule #1: Remember That Penny Stocks Are Risky
Risk is all part of the game when it comes to penny stocks. If your investment were guaranteed, things would be boring. So here we have cheap stocks trading for less than a lot of those coffee drinks you’ve probably bought at Starbucks (NASDAQ: SBUX). One slight move of a few pennies can be the difference between doubling your money and losing it all. For instance, when you talk about penny stocks under $0.10, just a 5 cent move can make for a huge win or a crippling loss.
Penny Stock Rule #2: No One Goes Broke Taking Profit
This sounds so simple, but traders have such a hard time sticking to this rule. Since these stocks move so big, it’s hard for some to adhere to their rules. They may go into a trade setting a goal to make 20%, for example. But then to stock explodes 50%. Where most disciplined traders would take some or all profit at that point, novices tend to do something different. They start letting emotion direct their trading style.
If this sounds familiar, then this rule is for you. Selling at your profit targets is important because what “if” the stock falls apart after selling? Worst case scenario is you leave money on the table. I know it’s depressing to see what you “could’ve made,” but 9 times out of 10, if the trend is stable after you sell, there should be opportunities to re-enter the trade. No one has gone broke by taking profits off the table. At the end of the day, this is your goal.
Penny Stock Rule #3: There’s No Substitute For Learning How To Day Trade
I know how easy it can be to pay someone for “signals” or “penny stock picks.” But when they aren’t around, what do you do? One of the most important things as a trader is actually to know how to day trade in the first place. If all you do is follow someone’s “alerts,” you’re doing yourself a major disservice. If that person or social media account disappears tomorrow, what do you do?
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Well, if you’ve learned how to day trade, then you go on with your day without skipping a beat. But if you solely rely on someone’s next pick, you are at an extreme disadvantage and risk moving on to the next “guru” who may not have your best interests in mind. Believe it or not, everyone on social media is trustworthy.
These are words to live by when it comes to day trading. It’s easy to follow the herd. We saw it with stocks like GameStop (NYSE: GME) and AMC Entertainment (NYSE: AMC). But look what happened just a few days after. These stocks crumbled, and you best believe that social media chats and discussion forums were full of “what do I do now” posts. If they understood how to day trade and stuck to Rules #1 and #2, they wouldn’t be wondering what to do next.
Penny Stock Rule #4: Control Your Losses
Just like there is no substitution for education, there’s no substitution for a proven strategy. This should involve controlling your losses. If you make enormous gains but follow that with significant losses, you’re inefficiently trading. Your wins should fluctuate from small to large, but your losses should always be kept small. One way to do this is through tier trading. It involves breaking up your entry and exit into pieces. While this article isn’t about how tier trading works, I’ll give you a brief 30,000 ft overview.
Let’s say you want to put $1,000 into a position. Instead of going all-in, you tier in with a small test tier or “tier 1” position. This would be something like 20-25% of your total allotment. Now, if the trade goes south, even if it rips lower by 50%, you’re taking a 50% haircut on $200-$250 and not $1,000. In this example, even a considerable loss of that magnitude is only 10%-12.5% of your actual allotment you planned to invest. You just avoided taking a $500 loss by taking up this new trading approach.
Now, let’s say the trade didn’t fall apart and started working out. Now you’ve got a lower cost basis to work off of. You’d then scale into the position with a larger tier, this time something like 40-50% of your total allotment ($400-$500). As the trade continues working in your favor, you start selling out of your position in tiers, taking profit along the way. This can actually help you stay in a winning trade longer because, theoretically, your cost basis should remain lower than the stock price as long as it continues higher.
Penny Stock Rule #5: Don’t Forget These Rules
Remember that these are just a few of the main rules of day trading penny stocks:
- Penny Stocks Are Risky
- No One Goes Broke Taking Profit
- There’s No Substitute For Learning How To Day Trade
- Control Your Losses
Don’t think that these are the only rules to learn. Like I said above, you’re going to experience so much more during your trading career. But it’s crucial to have a set of rules that establishes the basis for your individual style.