5 Simple Steps to Minimize the Risk of Trading Penny Stocks

All investments carry risk. This is probably the first lesson you will learn from any good investment book, course or teacher. The whole risk-reward dynamic is a very important concept that you have to understand before you even start trading. When it comes to trading penny stocks then the prevailing opinion is that they are high risk stocks to trade.

Although this is definitely true, there is more to it. Legendary investor and trader extraordinaire Warren Buffet once said that “risk comes from not knowing what you are doing”. A very good warning indeed. So often we tend to see something as risky simply because it is considered risky.

Who would ever have thought that a “risk free” stock like General Motors or Ford will ever become as unstable as they have in 2009? The fact remains that all investments have risk attached to them, but without risk there can be no reward.

I believe that penny stocks and small cap stocks have great opportunity and despite the risk warnings, we can really trade them with great leverage. Here are 5 simple steps you can take to significantly reduce and even eliminate the great risk that so many traders warn against when trading penny stocks.

1. Never trade on “hot tips” from a friends friend who knows a trader.
This has been the downfall of many inexperienced traders who think they get an inside scoop while they are just being suckered by market hype. Be careful who you listen to and only trade “hot stocks” that you find yourself.

2. Don’t get carried away
With penny stocks being so cheap and the promise of massive returns so tempting, we can easily get carried away. You know when you make little sums in your head – calculating how much you can make before you even trade the stock. Never assume and keep your emotions in check. When you get too involved emotionally you will make mistakes and break your own trading rules.

3. Never trade blindly
For some reason many traders ignore good trading principles when trading penny stocks. Although the rules are slightly different, you should always keep your focus on making good trades based on solid decisions. Look at the graphs and analyze the patterns and trends. Let the trends guide you, not your hunches.

4. Never count on a sure-thing
You should trade every stock with a neutral frame of mind. Never bank all your hopes on a stock being “the one”. As a rule of thumb you should never trade more than 20% of your trading account on a single stock. This way your emotions won’t run away from you and if (as is most often the case) you lose your good sense temporarily you won’t lose more than you can afford to.

5. Be responsible for your own trades
The old saying that no one cares as much about your money as you hold true for trading. There’s a lot of websites out there offering to trade “for you” – all you have to do is hand over your money. Be very careful. In the end you are the only one who can really be responsible. Get all the help and advice you can handle, but make sure that you are fully in command of your money and your trades.

By applying these five simple rules you can greatly eliminate the risk involved in trading penny stocks. If you combine this with some good solid stock picking techniques you can do very well with small cap stocks. In the end they are good investments. They are cheap and can give you buying power unlike any other investment out there. Stick with it, educate yourself and be smart.