What attracts investors to trading penny stocks is the opportunity for a trader to make quick profits in a very short period of time since penny stocks can be very volatility and move fast in a short time frame.
Many consider trading penny stocks to be much more riskier than trading a normal stock. Sure, penny stocks can be risky but with a set of rules that you set for yourself much of the risk can be eliminated.
Like trading any other stock, trading penny stocks apply to many of the same rules. Below is a list of trading tips or rules that will help you become a successful trader in general, but also carries over to trading penny stocks.
#1. Focus on Capital Preservation & Risk Management
The most important thing in trading is capital preservation and risk management. Both go hand-in-hand, if you don’t have the proper risk management then you won’t be able to preserve your trading capital.
This should be your number one goal before trying to grow your capital. Without proper risk management and preserving your capital, you can end up losing alot of money and be out of business as a trader. Once you have mastered this, then profits will take care of itself.
In trading, you have good trades and bad trades, and hopefully, through a consistent approach, you make money overall. Trading is not about trying to hit “home runs” by taking excessive risk on any one position.
You can’t control the markets but you can control your money and your risk on each and every trade that you make. You can preserve capital by the amount of capital you put into a single trade and limiting losses by having stop-losses set in.
Most traders would agree that you should not risk more than 2% of your overall trading capital on a single trade. For example, if you have $25,000 in your trading account, two percent of this amount is $500. That is the maximum amount you can lose on a trade.
That doesn’t mean you should put $25,000 down on a single trade. A good rule is not to put more than 10-20% of your trading capital in a single trade. When trading penny stocks you might want to consider putting less amount of capital into a single trade.
#2. Stick with Trading Liquid Penny Stock
Before trading in penny stocks, make sure it is liquid, which basically means the ability to get in and out of a position with ease. In a highly liquid stock you are able buy or sell it rapidly as soon as you put in your order.
In some penny stocks, liquidity can be an issue, some penny stocks are thinly traded with very little volume and often have low liquidity, making it often difficult to buy or sell shares.
A good way to check if a stock is liquid is check its average daily volume and check the spread or the difference between the bid and the ask price, and if the bid and ask price of the stock are relatively close along with good volume then it has good liquidity.
#3. Limit Losses – Always Use a Stop-Loss When Trading Penny Stocks
Penny stocks can move very rapidly and you can risk losing alot of money fast, so you should always have a stop-loss order set in when trading penny stocks.
A stop-loss is designed to limit trader’s loss on stock, just in case the stock they are trading goes against them.
So, what is stop loss order? It is an order placed with a broker to automatically sell or buy (depending on if you are long or short) once the stock reaches a certain price. Setting up stop-loss order at reasonable price limits is a must in trading penny stocks.
So how tightly should a stop loss be set? It all depends on how much you’re willing to lose on that single trade. Many traders set it at a certain percentage and others set it at a particular price point, it all depends on the trader’s trading style. But, a good rule is that you should never lose more than 2 percent of your overall trading capital on any signal trade.
It’s important to have a stop loss in while trading penny stocks, so that you can cut your losses early and not let
small losses become large. Then you are able to concentrate your efforts on another stock that may turn out better.
#4. Lock in your profits
Since many penny stocks are volatile and move fast, you need to lock in your profits. Many traders fail to safeguard their profits and don’t get out at the right time.
There are different strategies to ensure your profits are locked in. You may want to scale out of your position at different price levels or maybe sell at least half of your position. Then wait to take profits on the other half as it reaches another price target and then set a stop order to where you entered the trade.
Another option you can do if you are up in the trade, is put in a trailing-stop. A trailing-stop is typically set at a percentage level below the market price and the trailing-stop price is adjusted as the price fluctuates. A trailing-stop will ensure that profits are locked in.
#5. Don’t buy on Margin if you are a beginner
You shouldn’t buy stocks on margin if you are a beginner trader and especially don’t buy on margin if you are trading penny stocks. Penny stocks can be very volatile and have sharp movements of ups and down.
What is Margin you might ask? Margin is borrowing money from your broker to buy a stock and using your investment as collateral. Investors generally use margin to increase their purchasing power so that they can own more stock without fully paying for it.
Margin is a great tool if you are an experienced trader and have mastered discipline. But, the downside to using margin is that if the stock price decreases, substantial losses can mount quickly and margin can ultimately wipe your trading account quickly if you are inexperienced.
#6. Don’t over Trade
Do NOT over trade just because you feel like you need to do something or because you want to make more money.
Remember the old saying:
“all good things come to those who wait” – well in trading this is very true as it is always best to wait for right trading opportunity to present itself.
You should never force yourself to find stocks to trade, because in the end it may go against you at the worst possible time. Over trading will cause you to lose your focus, discipline and in the end will almost always causes you to lose money because you won’t be concentrating your efforts on finding trades that have greater probability of making you money.
Do not be in too many positions at one time. Also, if you felt like you missed out in a good trading opportunity, don’t try to make up for it by trading in something else. Just learn from it, be patient and remember another trading opportunity will always present itself soon!
The more you trade, the more risk you take. And don’t trade outside of your trading style, just because you want to trade. Just be patient and wait for the right setup that meets your trading criteria.
#7. Don’t Be Emotional
Traders might face many emotions from the excitement or thrill of making a great trade, to panic of trying to get out of a trade, or maybe depression after losing money, and many other range of emotions.
One of the keys to become of successful trader is if you master your emotions then you will master the market. In trading you must be logical, not emotional – you must stick with your trading system and rules and be disciplined.
Trading is a business and you must treat it like one.
#8. Keep a Trading Journal
When you trade a stock, you should always document your trade, thoughts and experiences in a trading journal. A trading journal is a great tool so that you can go back and review trades after the fact and analyze what worked and what didn’t.
For example, you can write down your entry & exit points in a trade, write down the mistakes you’ve made, as well as things that you did right in that trade. By referring to a trading journal, a trader can learn from their successes and failures, and ultimately help improve you as a trader.