Plenty of people think of penny stock traders like the cowboys of the Wild West, as if we were all running around some kind of lawless financial environment – jumping in and out of volatile stocks at the slightest twitch of the market.
But the thing is, trading like that – without any rules in place to protect your trades and your income – isn’t just dangerous. The losses you take on poorly planned trades can be enough to ruin you financially! This is why I work SO hard to educate mystudents to stay disciplined when trading penny stocks.
Any good trader knows that having rules in place to guide buying and selling decisions is the key to long-term success. If you don’t already have your own framework, watch these free penny stock videos and check out these ten rules to get you started, based on my own experiences as a penny stock trader:
Rule #1 – Never invest more than you can lose
I talk a lot on this site about the vacations I’ve taken (100 countries and counting!), the houses I’ve bought and the other perks I’ve been able to enjoy because of my success as a trader.
I can’t help it – I’ve worked hard for these things, and I love that my career lets me live my millionaire lifestyle.
I want you to enjoy all these benefits too, but I don’t want you to put your finances at risk by buying things or making trades you can’t actually afford. Aspirational thinking is great – aspirational buying is not. And remember, you need money to make trades in the first place! If you wipe out your cash on a trade you couldn’t really afford, you won’t be able to take advantage of the next truly hot stock that comes your way.
Bottom line: If you can’t afford to take a loss on your trade, don’t make it in the first place. If you take absolutely no other piece of advice from this article, make it this rule!
Rule #2 – Track everything
I track all of my trades on Profit.ly (check out my account here), so if you really want to know what I’m up to, all you have to do is take a look.
But the thing is, although teaching is a big part of what I do, I’m not just sharing my picks to help my students. I’m also doing it because having a record of every move I’ve made helps me learn how to be better in the future.
Download a PDF version of this post.
If I have to take a loss on a stock I’ve covered, I can go back, check my notes and see how I might have done things differently. Sure, it’s not possible to get a win every time, but reviewing my losses (and my wins) helps me make better decisions when I find myself in the same position again.
If you’re new to penny stock trading, tracking your trades is one of the best ways to learn about different trades and patterns, as well as how you should increase or decrease your positions in response.
Rule #3 – Pay attention to volume
Volume is just one of the factors I look into when picking stocks, but when I talk about volume, there are actually two things I want you to know:
First, you’ve got to pay attention to daily trade volume. I only ever get involved in stocks that trade a minimum of 100,000 shares a day. Any less than that – especially if the same stock is trading at $0.50 a share or less – and I start to get worried about its liquidity.
But I also look at volume in terms of my position relative to the company’s volume. If you get into a stock for more than 10% of its daily trade volume, it gets much harder to get out of the position quickly. It’s an expensive mistake I’ve made in the past – and it’s one you can avoid just by following this rule.
Rule #4 – Don’t put too much stock in promoters
I was originally going to write this rule as “Don’t ever listen to promoters,” but there is one exception to that: If you know promoters are pumping up a stock artificially, you can sometimes work against them by getting in at the top and making money as it inevitably trends back down!
But in nearly all other cases, you’re better off ignoring what stock promoters (or worse, company managers who are lying to keep their businesses afloat) have to say.
Not sure how to tell what’s real and what’s not? For one thing, watch out for puffed up press releases promising explosive gains – promoters are pretty much always behind them.
Instead of hopping on something that sounds too good to be true (and probably is), do your homework. If you can’t find reliable information on a company, move on – there are just too many other great opportunities out there to take advantage of than to waste time on potential scams.
Rule #5 – Get out of trades when they don’t go your way
This rule – like a few others on this list – is easy to read, but hard to implement.
But if you want to avoid exposing yourself to huge potential losses, you’ve got to be able to get out of trades if they aren’t going your way – even if they’re gaining.
Am I really telling you to take a smaller profit on a stock that’s trending up, just because you didn’t expect that movement?
It sucks to watch a stock you’ve sold climb higher – trust me, I’ve done it over and over again. But putting this rule in place and following it all the time is the best way to protect yourself from the downside risk of big losses on unpredictable trades.
I guarantee, if you follow this rule, you’ll save yourself much more in avoided losses than you’d gain by staying in trades whose growth you didn’t predict.
Rule #6 – Be able to go both long and short
A lot of people want to rip on penny stock traders, but the thing is, there aren’t many other opportunities in the stock market where you can make predictable 30-70% profits in a day.
If you want to earn that kind of income, though, you’ve got to learn how to short stocks.
Shorting involves finding stocks you think will decline in price. You can then arrange to “short” them, means taking out a loan for these shares from a broker and then selling them back into the market. As the stock’s price falls, you’ll earn the difference between what you sold your shares for and the cost of the loan from your broker.
The stigma that a lot of people have towards penny stocks means that most of them operate according to pretty predictable patterns. If you can learn these patterns and learn when they’re telling you to short a stock, you can achieve some pretty huge returns.
You won’t win every time, and you’ll find that not all brokers allow you to set up this type of transaction. But when it comes down to it, you don’t have to win every time – just most of the time.
Rule #7 – Focus on risk-reward
A lot of traditional investors use hard stop losses to decide when to buy, hold or sell, but the bid-ask spreads on penny stocks can be high enough that these moves can actually lose you money.
Instead, I prefer to focus on risk-reward models.
Let’s say I’ve got a $3 stock and I want to make $1 a share. In this case, I’ll cut my losses at $0.20 so that my risk-reward ratio is 5:1. In general, I want to see risk-rewards of at least 3:1 or 4:1 – there’s just not enough in it for me if the potential is just 1:1 or 2:1.
Using these mental stops, rather than hard stops, lets you take advantage of the liquidity of penny stocks without putting too much of your capital at risk.
Rule #8 – Never fall in love with a stock
Every company you’ll see as a penny stock trader has a great story about how they’re going to disrupt their market or change the world.
And you know what? That might be true – but it shouldn’t mean shit to investors.
The second you start thinking about a stock in anything other than the strictest financial sense is the second you start making emotional decisions that don’t follow these rules or your established trading framework. And emotional decisions are rarely smart ones.
Don’t be that guy who takes a huge loss on a stock he couldn’t bear to part with! Keep your relationship with your stocks on a strictly professional level.
Rule #9 – Don’t let your ego get in the way
On a similar note, you aren’t perfect. I’m not perfect – even after $4.2 million in profitable penny stock trades.
But time and time again, I see investors sticking with stocks they believe in, just because they don’t want to be wrong. And yeah, it can be embarrassing to be stuck on the losing side of a trade you thought you’d win, but you know what’s even more embarrassing? Losing more money than you had to because your ego kept you from cutting your losses quickly. Never let a failed short-term trade turn into a long-term investment.
The numbers don’t lie, and a stock isn’t going to change course just because you believe in it.
If you want to be successful with penny stocks, you’ve got to learn to recognize your losses and cut them quickly. Get your ego out of the picture – the decision to move on a position is a business call that should be based on numbers, and numbers alone.
Rule #10 – Every trade is a lesson
I’ve been in the stock trading game for nearly 15 years, and I’ve made millions of dollars in that time. Even still, I manage to learn something new every day – and I recommend you do the same!
You can learn a lot from trading videos and from reading blog posts by successful traders, but one of the best teachers you’ll find is your own portfolio. If you take a loss, look at where you went wrong, what signs you might have missed and how you can make better decisions in the future.
But you can also learn important lessons from your wins. If you’ve turned a profit on a trade, review the patterns that led you to make that decision so that you’ll get better at spotting them in the future. Review the stock’s trend to see if you should have gotten out or stayed in longer…this is whyis SUCH an important tool to help you keep an HONEST diary of your trades.
This great penny stock trader understands it well and he has ALWAYS said his key to success is his ability to focus on strategies and patterns that have worked well for him in the past and ignore patterns/setups that have not made him money.
Every piece of information you gather from your past performance will make you a stronger, wiser and more profitable trader in the future.