When you trade in penny stocks, there are a number of steps that you can take to ensure that you manage the risk of any potential losses. A good trading strategy always relies on making sure that you protect your portfolio from losing value. Portfolio risk management is critical to any successful strategy and a basic strategy should be implemented at minimum to prevent major losses. There are a number of steps that you can take to secure your shares from being hit with significant losses and some of these are discussed below.
Setting Limits – Buying penny shares can sometimes be a challenge; it is not unusual to see the share price swing from one direction to the other during the course of the day. As a buyer, or a seller of a stock, it is in your interest to get the cheapest price when buying or get the highest price when selling your stock. So in that case, it is vital that you watch the price swings and bid and ask price (the price you buy and sell) closely throughout the day. The best of investors know how to time their buys and sales to ensure that they get the best price.
So if you are looking to buy a stock, set a limit order to get the price. A limit order means that you don’t end up paying above a certain price that you have set. The same also applies for when you are selling a stock. Set a downside limit to ensure that you don’t sell your stock too cheaply. If you cannot get the price that you need for either buying or selling, there is always the option to wait until the next day to try again. Let the limit orders work for you to allow you to get the best prices available during the day.
Stop Losses – A trading stop loss is designed to execute a sale of a stock if it falls to a certain level. When it comes to penny stocks, the priority of an investor should be to make sure that if the company experiences sudden problems, and the stock price plummets, the stock can be sold before everything is lost. By using a stop loss, you can set a level at which if a stock falls; an automatic sale is triggered to reduce potentially bigger losses. Stop losses are especially useful for penny stocks, since it is not uncommon for small company shares to see big swings in their price. Unlike bigger blue chip stocks where if a big dip in price can be eventually recovered, major price dips in smaller penny shares can pose a bigger threat since smaller companies don’t have enough capitalisation to be able to cope with significant losses. Stop losses help you limit your losses against these potentially large falls.
Different investors will have their own approach to how they manage risk with stop losses. Some aggressive investors will choose to expose themselves to higher risk by setting stop loss levels to as much as 50% i.e a sale of the stock is triggered if the share price falls by 50%. More risk averse investors will choose more cautious levels such as 10% to 15%. The levels you choose should be based on in depth research and how much of a risk you are intending to take for a particular share. They should be in line with how much you can afford to lose. If you are heavily invested and cannot afford to big losses on any particular stock then it is better to set “safer” levels. If you have a good level of capital then you may be in a position to take bigger risks. Whatever your strategy, the key thing to remember is that stop losses allow you protect your investments form being completely wiped out in case of unforeseen downside movement.
Have a target and stick to it – There is a saying that says leave some profit for the other guy. In case of penny stock investing, if you have invested in a share and have enjoyed some good gains, you need to decide when to cash in the profit. In fact, knowing when to cash out is one of the most important decisions you will need to undertake. If you sell too early, you may end up enjoying lesser gains, if you wait too late, the stock may end up turning lower thus lowering your profit. The best way to decide when to sell is to set a target price for your share. So when the price reaches a certain level, you sell.
Setting a target price will help you maintain and keep your profit when it has gone up sufficiently. Setting a sale price helps you stay disciplined and prevents the greed factor from creeping in, which can cloud your investment judgement. The critical thing to remember is to never get passionate about the same stock. A disciplined and an emotions free approach makes stock investing successful.
Adjust your stop losses – If you find that your stock is slowly climbing upwards then you may need to consider adjusting the stop loss level. For example, if your share climbs up by 15% to 20%, you will want to consider setting a new stop level price more closer to the original purchase price of your share. If it continues to go higher, you will want to think about nudging your stop loss higher.
If you have a rising stock then another consideration you will need to have is to consider selling part of the stock to re-invest the profit in another one. This is a great way of diversifying your portfolio. Diversification is important to ensure that you are not only realising gains from one stock, but you are exploring the potential of other shares to benefit from a diversified portfolio.
So although there are thousands of stocks to choose from, careful and meticulous research will help you narrow down a handful of stocks to add to your portfolio. Simply some of the above basic principles of investing to your stocks and you should be able to manage your investments better than most.