How to Limit Losses and Lock In Your Penny Stock Gains
Penny stocks can be risky, but winning investors apply certain strategies to lower the downside risk while taking profits off the table. Although, there is no fool–proof plan, you can take steps to lock in your gains.
Position sizing is one of the most powerful, yet misunderstood, methods for protecting your portfolio. This strategy involves limiting each individual purchase to a predetermined percentage of your portfolio. For example, if you have a $20,000 portfolio, you may decide to limit your largest purchase to $1,000, or 5 percent of your portfolio. This strategy limits your upside, but it also insulates you significantly from downside in any one investment.
The amount you want to invest per trade is up to you. Investors with larger portfolios may buy more at a time but still keep the total purchase to 5 percent. Others may be more aggressive and risk 20 percent per trade. Whatever amount you decide is best for you, the point is that you limit your total exposure per trade.
Smaller portfolios don’t work as well with position sizing. If you only have $750 to invest, there is no point in dividing it up among eight penny stocks — the commissions alone would wipe you out.
However, a trader with $300,000 may benefit by maxing out her buys at $5,000, which theoretically would leave her with 60 different stocks and a total risk per investment of $5,000.
Combine position sizing strategies with stop-loss orders, and you will have a very secure portfolio. Add the scaling in and out concepts to your overall approach, and you’ll very likely be a successful penny stock trader!
You’ve more than likely heard that diversification is an important aspect of investing. Diversification involves buying lower amounts of more stocks to protect yourself from the downside of any one of them. In other words, don’t put all your eggs in one basket.
You can diversify your investments by
Region of the world or country
Stock market or parent exchange
Type (stocks, bonds, real estate, and so on)
Diversification is appropriate for many investors, but the strategy doesn’t help you achieve dramatic returns. The more you diversify, the closer your returns will mirror the market average you will achieve.
You can practice pinpoint investing, in which you buy six or seven penny stocks at most at one time rather than spreading the risk around. This way the increasing share prices represent more of a percentage gain, but the losses are also more severe on a percentage basis. Although pinpoint investing isn’t appropriate for most, if you’re comfortable with your research and analysis skills, pinpoint investing is appropriate for you.
Limit orders are the best way to control paying too much or selling too low in penny stocks. Every investor in speculative and low-priced shares should use them.
Use only the best markets
Not all stock markets are created equal. The better stock exchanges have stricter reporting requirements, listing fees, regulations for managers, and a higher degree of investor visibility. As a result, better penny stocks migrate toward these superior stock exchanges while the inferior companies tend to collect among the inferior markets.
By investing only in penny stocks on the best stock exchanges, you dramatically, easily, and instantly improve your odds. At the same time, you significantly insulate yourself from all the shady companies and thinly traded penny stock pump-and-dump investments.