by Jeff Reeves | June 19, 2010 12:21 pm
Finding hot penny stocks to buy can be a daunting task for any investor. Simple investing strategies often do not apply to penny stocks simply because these investments tend to be small companies with little analyst coverage and often not a lot of information floating around on the internet. But even though penny stocks investments can be tricky, it’s crucial for many investors to consider these picks for their retirement portfolio. There’s simply no other type of stock pick out there that can make you the same amount of money in the same amount of time as a hot penny stock.
That said, choosing the wrong penny stock can really hurt your portfolio and dry up your retirement funds in a hurry. That means the trick is to know how to limit your risk but still maximize your upside potential from penny stock investments.
Whatever your retirement money goals are or whatever investment strategy you follow, penny stocks should play an important role. To help you pick the best small cap investments to buy, here are seven simple rules to follow when developing your penny stock strategies:
Don’t buy pink sheet penny stocks. Pink sheets or OTC securities are risky bets since stocks do not need to fulfill any requirements such as filing regular financial statements with the SEC. Also, many pink sheet penny stocks do not meet the minimum listing requirements for major U.S. exchanges — and as such, probably don’t meet the minimum risk standard for your portfolio. There are a host of low-priced stocks trading for just a dollar or two on the NASDAQ and NYSE, so stick to these picks to find good penny stock investments.
Ignore dividends. If you’re investing in penny stocks, it should be with the portion of your retirement money that you’re prepared to keep in fairly aggressive and risky investments. As such, dividends shouldn’t enter into the conversation. Besides – many penny stocks that appear to have massive dividend yields are simply using a trick of math where a one-time payout is annualized out. These special dividends are often unreliable and make a poor selling point. Ignore all dividends when picking a penny stock investment. While the payouts are nice if you qualify, they should not be your deciding factor on when to buy or sell these fast-moving stocks.
Focus on earnings, analyst upgrades and hard numbers. It’s easy to get caught up in the buzz about a new biotech stock with a cutting edge treatment, or to believe that a new tech stock is going to change the world. But the harsh reality of penny stocks is that they won’t make you any money unless they are making money themselves. That’s why you need to focus on quarterly earnings and sales numbers, expert analyst upgrades and downgrades and other hard figures that put the strengths and weaknesses of a penny stock in black and white. Rumors and tips are common in the penny stock investment category simply because of a lack of information. But all that means is that the few snippets of real data you find should become all the more valuable when you invest.
Always use limit orders when trading penny stocks. Placing a market order on a penny stock can be a bad experience, since most of these companies are thinly traded and can jump around dramatically over the course of a trading day. That’s why it’s important to never trade after hours and never just click “sell” on your online brokerage account. When buying, pick a reasonable entry price — for instance, 10 cents above the previous day’s close — and set a limit order. This will prevent you from overpaying. The same goes for when you sell your stock. Cap a downside limit to get the best price, and if you don’t meet that mark during the trading day just wait until tomorrow to execute your sale. Savvy traders can probably get the best returns by watching the bid-ask prices – that is, what investors are getting right now for the shares they are buying or selling — but the simple trading strategy here is to just set a limit order and wait for it to do the work for you.
Set a stop loss once you buy in. For many investors, it’s easy to rationalize away the “paper losses” you see in your portfolio – especially if you’re of the buy-and-hold mentality. After all, if your blue chip holdings dip 10% or even 15%, there’s a good chance they will bounce back if given a few months or even a few years. But with penny stocks, those assurances often don’t hold up. By their nature these companies can be small outfits just one disaster away from bankruptcy. The big blue chip conglomerates can suffer through multimillion-dollar writedowns, but not small cap stocks with a market cap of just a million dollars. That means you always have to protect your downside with a stop loss. Aggressive investors can limit their downside to as much as 50%, but less adventuresome types should consider something in ballpark of 10% to 20% limits on the downside.
Set a price target for your penny stocks. Wall Street is not a casino, and just “letting it ride” is almost always a bad idea when you’re up by a bundle. Every penny stock investor needs to have a realistic price target — a 30-50% gains for more conservative types, and as much as 100% gains for those who really want to be aggressive. Once those targets or hit, you should be able to walk away. If you don’t want to sell all of your shares that’s fine — just sell a portion of your position. While it can be difficult to sell out of a stock and watch it continue to rise, it’s important not to get greedy. The purpose of setting a price target on the front end is to have a reasonable goal — and then protect your gains once those goals are attained. The trick is to never put all your eggs in one basket and fall in love with a penny stock just because it has been good to you in the past. That’s a sure way to get burned.
Revise your stop losses and sell partial positions regularly. If a stock tracks slowly upwards but doesn’t hit your appointed price target, it may be necessary to revisit your stop loss to protect your gains. For instance, if Penny Stock A is up 15% you may want to set a new stop at your original entry price — not the original downside threshold placed during your initial purchase. Similarly, if a stock continues to track upwards but never reaches its price target, you may want to reinvest some of those gains in another penny stock instead. For instance, if Penny Stock A jumps 30% but you were hoping for 50%, why not sell half your shares and buy a position in Penny Stock B as well? That will keep your money working for you in the first pick so you don’t miss out on any profits, but also add to your diversification and protect the money you’ve made. The point here is to remember that not every penny stock has a clear moment when it becomes a sell — so it’s up to you to protect your retirement money by regularly giving your stocks – and your penny stock strategies a check up.
As of this writing, Jeff Reeves did not own a position in any of the stocks named here.
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