The Art of Mastering Finance

Six Cardinal Rules of Penny Stock Trading

Penny stocks, also termed cent stocks in some parts of the world, are common shares of small companies trading with low per-share prices. There is hardly a shortage of such companies, but to be successful, you need to create a penny stock investing plan, and that includes following the most basic rules every penny stock trader should observe.

1. Use limit orders at all times.

As explained by their nature, penny stocks are very thinly traded. Thus, the deviation between the bid and the ask is often substantial. Investors using market orders may be at the mercy of market makers seeking a quick buck. To keep the market maker from buying or selling at any price, limit orders must be used. That means, when you buy or sell penny stocks, your terms – not the market makers’ – will be followed.

2. Keep within regular trading hours.

An absence of volume can lead to after-hour trades that are illogical and most definitely do not represent a good match of buyer and seller. Even a few pennies can make a tremendous difference when it comes to penny stocks. By trading within regular hours, you can ensure an efficient trade.

3. Never chase Performance.

For whatever reason, there are investors who only buy after a stock moves up. As a stock soars, these folks believe that it’s safe for them to make a move. But this is far from the truth. Typically, by the time they decide its safe, the opportunity has passed them by, and then losses come in. What’s actually safe is to stick to new recommendations and the accompanying buy limits.

4. Keep your holdings to 20 to 30 positions.

This is a rule of thumb. Maximum gains could be achieved with 20-30 positions. More than that and you get a dilution of returns. Lower than that and you get a significantly lagging performance. Worse, if you buy too few stocks, you will likely lose big.

5. Trade with a reason.

Owning a stock that already has shot up in value is acceptable, as long as you have good reason to do so. “You can call these reasons “triggers. If a stock has no trigger, it will never take off.

6. Expect three months as average holding period.

Lastly, keep in mind that penny stocks are extremely volatile creatures that can rise and fall any minute. Expect big gains up to a maximum of 90 days. If that move does not take place, check out your next opportunity. There are times when you may have to go back and forth on a certain stock due to the volatility. You won’t see any rapid-fire day trading, but if you foresee a stock’s value going down and vice-versa, the best thing to do is to sell it.

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