Investing in Penny Stocks – Know The Rules

penny stock

Many investors have made a quick buck by investing in these companies and benefitting. However, you need to be cautious, even more so if you’re dealing with discount brokers who will not enumerate the risks involved. Before being tempted by the lure of easy money, you must remember the following:

They should not account for more than 10% of your equity portfolio. Invest in a handful of scripts instead of spreading your money across a basket of low-priced stocks, buy only 2 or 3 shares. They will be easier to monitor. Keep it a short term gambit and set a reasonable target and exit when it is achieved. Do not hold them forever. Don’t trust anyone. Online share trading is a game. Everyone will paint a rosy picture. Take the stories you read with a pinch of salt. Make sure of a high volume. Remember that a low volume will lead to low liquidity. Don’t let overconfidence ruin you. Even if you have been lucky for the past 5 times, there is no reason you will have an equal benefit the 6th time.

Usually, the stocks are penny for a reason. Most of the companies make their debut after becoming mature. People often say Microsoft was also a penny stock once – it never was. Be cautious and be wise. If you don’t trust yourself, find a full service broker and listen to him.

Today the investors are smart enough to understand that there are associated risks of investing in low priced penny stocks, but still even the small investors didn’t hesitate to invest their large sum of money in these stocks. Now, why do they do so when they know and understand the inherited risks of their investment? The reason is simple, they have booked quick profits in the past by investing in these penny stocks and tempted with their past profits, they stand up again to invest in these stocks. If you think that you also belong to this category of investors or you feel that one day you will want to fall in this category, then you should be aware of few rules of the game. Even when you know and follow the rules, never make yourself forget that investment in these stocks is risky. Let us have a look at some of the rules:

  • Go with the small amounts – Never dare to put a big amount in penny stocks unless and until you have an appetite to bear the losses emanating from investment in these stocks. The ideal pie of penny stocks in your portfolio should not go beyond 10% of your total portfolio. In addition, you must not invest more than what you can afford to lose.
  • There is no use of diversification – The rule of diversification is not applicable for penny stock investments. Therefore, there will be no use of picking a large set of penny stocks. Keep your investments in these stocks limited to 2-3 scripts only as it will be easier for you to keep a watch on 2-3 scripts rather than monitoring 10-15 scripts
  • Invest only for short term – Penny stocks should never be considered for long term. If you are keen on making investment in these stocks, then it will be better if you invest only for a short period of time. The moment, you see a sharp rise in the price of these stocks, it will be a time to make an exit from it and sell at least a part of your penny stock holdings.
  • Believing is not the key – You can definitely check the forums, look at the trends and do lot of analysis on these stocks, but the true word of caution is – don’t trust anyone, not even the management of the company.
  • Don’t buy stocks with low volumes – If you have really made your mind to invest in penny stocks then choose those stocks which carry a high transaction volume. The low volume stocks should seriously be avoided. You may also come up across shares with a total transaction volume of only say 10 shares in a month and now, if you invest in these shares, then accept that you have unnecessarily blocked your money, as at the time of exiting from the share, you will find it difficult to offload it. Therefore, investing in a high traded volume stock will be a still safe bet.
  • Averaging does not work here – I am sure you must have heard of a debt trap where you take a loan to offload the previous loan and you keep digging a bigger hole for yourself. Same will be the condition if your try to average out your losses from penny stocks. For example – if you purchased penny shares of Rs. 8 and the price falls to Rs. 6, then in order to average out your losses, you decided to purchase more shares at Rs. 6. But this is not going to solve your problem and take you out of losses. Rather, this way, you will be digging a bigger hole for yourself and you might end up sustaining a bigger loss. So the better way out of the situation is either to wait for the condition to revive or gracefully accept your losses and exit from the share.
  • Don’t let overconfidence rule you – Let us take a case where you have previously invested in penny stocks for 5 times and every time you succeeded in booking profits from these shares. Don’t be overconfident that you will be successful in the 6th chance as well as there is no trend and no consistent record while dealing in penny stocks.

At the first place, keep your hands away from the penny stocks. And secondly, if you can’t stay away from these stocks then at least in your interest, don’t forget the above mentioned rules. I can just hope that you will remember the rules of the game and will continue to book profits from penny stocks.

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