What to Know Before Investing in Penny Stocks

Anyone who has questions about how to invest in penny stocks should be aware of some things before they begin their journey into this convoluted area of the investment world. One of the first things I tell people who are interested in trading penny stocks is that you have to have a sober assessment of the risks involved in such a venture. You can’t fool yourself—this is risky business. That doesn’t mean that penny stocks are a bad idea—actually, they can be a stellar idea, provided that you know how to control those counter-productive impulses that can plague all of us as traders and investors. One of the most powerful things I’ve learned over the past (nearly) decade of studying and trading the penny stock markets is that there’s a huge difference between predicting the market correctly and trading the market correctly. You can accurately predict the price moves of every single penny stock you invest in, but that does not mean that you will trade them properly. It’s kind of funny, because the actual act of trading the markets is almost an entirely separate thing from the markets themselves. It’s a lot like the analogy of a surfer and the ocean. The markets are like the ocean, and we as traders are the surfers of this great ocean. The ocean does not care if the surfer can shoot through the tallest wave in history with effortless skill, and it does not care if the surfer drowns in a tragic accident. The ocean is the ocean, and the surfer would be an idiot to think that he can somehow "control" what the ocean does. You simply can’t. You have to learn how to adjust YOURSELF in light of what the ocean is doing. This may seem like I’m getting all "Tao of Trading" on you, or even just getting Mr. Miyagi on you, but I’m simply telling you what it’s going to take to invest in penny stocks successfully. And actually, the word "invest" in light of penny stocks is slightly inaccurate (in my mind, anyway), because penny stocks, in my humble opinion, are really more for speculation and trading than they are for long-term investing Warren Buffet style. If you are a trader, you are a gamer in a sense. Penny stocks require much more active participation than just the "buy-and-hold" strategy (which, by the way, can truly be a losing strategy over the long term). The reason why is that price moves in penny stocks can happen within VERY short windows of time, and many times it can be only a day or two of violent price movement with high volume, and then the price totally deflates and the party’s over. If you’re caught holding the bag after the party happens, you will lose money and you won’t even know what hit you.



For these reasons, I would say that anyone interested in learning how to invest in penny stocks really needs to do a sober assessment of their risk tolerance. Can you handle the market volatility? Can you handle price movements into the double (and even triple) digit percentages within days? Remember, when dealing with the price action of penny stocks, if a stock priced at $0.10 goes up to $0.15, it has just completed a 50% move. Those kinds of returns are phenomenal by any standard, and they are far from uncommon in the penny stock markets. As awesome as that sounds, you have to remember that the price can also decrease just as quickly and by just as much of a percentage as it can increase. The mentality that I have adopted is that whatever money I invest in a penny stock, I make sure that I can just as easily flush that money down the toilet. In other words, if I lose my entire investment, I won’t be financially ruined by it, and I won’t be emotionally devastated by it. As somewhat of a side note, I’m gonna tell you that I have experienced more emotional pain by taking profits too soon, only to see the stock go up into the stratosphere after I got out, than I have by losing money on a trade. That’s another side of it as well—you have to have the emotional stability to handle these kinds of price fluctuations, and you have to be able to keep your cool and stick to your trading plan even when the market volatility makes you want to vomit. In closing, I know that it seems like I’m focusing more on the conceptual side of investing in penny stocks, but you have to master these things before you can really even get to the "nuts and bolts" of penny stock trading. If you are willing to take the time to make an honest self-assessment, it will put you that much farther ahead in your journey of investing in penny stocks.