Finding a safe way to add Nasdaq penny stocks to your portfolio

Nasdaq penny stocks do sometimes pay off, but there are many pitfalls to avoid.

Some investors look to penny stocks as a quick way to boost their investment gains. But while buying penny stocks can lead to a big payday when you make the right choice, the odds against your success are high. Penny stocks are almost always involved in riskier ventures, such as finding mineral deposits that can be mined at a profit, commercializing unproven technologies or launching new software. Even if you want to take on that risk, you need to be extra careful about the penny stocks you do buy.

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Nasdaq penny stocks and appeal of the new

At some time in their lives, many people feel a near-automatic attraction to things that are new or different.

People get used to the idea that it’s good to try something new. They get used to the idea that you can largely take advertising claims and glowing reviews at face value. However, when assessing financial commitments, those same attitudes are dangerous.

The problem is that the risks in bad investments are subtle—far easier to overlook than, say, a tiger’s snarl. That’s especially true of aggressive investments. Sometimes, the story is so good that success seems guaranteed, if you just hold on long enough.

For instance, investors may ask if a particular new stock issue or unproven tech stock or penny mine is a good choice for an RRSP. We explain that these investments are too risky for an RRSP. Some reply, “I don’t mind the high risk, because I plan to hold for the long term.”

They have it backwards. Well-established companies with a history of sales and profits, if not dividends, are your best choice for long-term investment success. They tend to survive the bad times and go on to thrive anew when good times return, as they inevitably do. You put the odds in your favour even more if you use our three-part strategy to build a portfolio of well-established companies.

The reverse is true of companies whose main appeal is that they have come up with something new. Most new private companies eventually fail. The risk is even worse with public companies. For every Facebook or Google, there are a million duds.

Main factors we look at when picking Nasdaq penny stocks

• When picking Nasdaq penny stocks, we look for a strong balance sheet with low debt, or a major partner engaged in financing.
• We look for well-financed penny stocks with no immediate need to sell shares at low prices, since that would dilute the interests of existing investors.
• We want to see experienced management with proven ability to develop and finance a new business.
• We avoid stocks trading at unsustainably high prices due to broker hype or investor mania.
• We compare the market cap of the stock with the estimated value of its mineral reserves, future product sales and so on.
• We avoid stocks trading over-the-counter where regulatory reporting and so on is lax.
• We insist on political stability.

Eliminating losing Nasdaq penny stocks from your portfolio

If you discover that a stock was a bad choice to begin with, or if you find reason to believe its outlook has soured due to some new development, then you should sell right away, regardless of what the rest of the market is doing. That’s different from selling because of how far it has fallen, or because you doubt that it will ever get back to the price you paid.

The best way to minimize losers is to understand the underlying message of our three rules, and apply them more diligently. Be very careful about the quality of stocks you buy. Diversify and balance your holdings. Avoid fads.

You’ll still have losers in your portfolio. But your gains should more than offset your losses, and leave you with a healthy margin of profit.

On the other hand, if you focus on getting the losers out of your portfolio, you may partially succeed. But watch out that you don’t get rid of winners too.

Have you seen positive returns on Nasdaq penny stocks over the long term or have you seen them perform poorly? Share your story with us in the comments.