Penny stock risks are very real and investors should use our 10 strategies to minimize those risks

Penny stocks tend to be more speculative, and are typically engaged in such early stage activities as finding mineral deposits that can be mined at a profit, commercializing an unproven technology or launching new software applications. That makes it all the more essential to fully understand penny stock risks and rewards when investing in this area.

Because success in penny-stock endeavours is so rare, it’s all the more important to look for investment quality to minimize penny stock risks.

It’s hard for any new company sto grow into a profitable business, and it’s even harder in pioneering fields. But it’s relatively easy to launch a stock promotion that claims to have answers to social problems or ways to profit from emerging technology. That’s why penny stock promotions are always more common than legitimate start-ups. Still, even legit start-ups often fail.

It may seem contradictory to use the terms “investment quality” and “penny stocks” in the same sentence. But there are even wider disparities in the investment quality of penny stocks than in better-established companies. We feel that investors can minimize their penny stock risks through their stock selection.

Here are 10 tips for minimizing your penny stock risk:

1. When possible, seek well-financed penny stocks with no need to over-market and over-promote their shares.
2. Seek experienced management with a proven ability to develop a penny mine, product or service.
3. We also like to see a major partner who can help finance the penny stock’s product or mine to production or commercialization.
4. We avoid penny stocks trading over-the-counter, where such things as regulatory reporting are lax. This alone can mitigate some penny stock risks.
5. Penny stocks promoters will often come up with over-inflated projections. Compare the market cap of the stocks with the estimated value of their assets or future earnings stream.
6. Penny stocks are notorious for putting a lot of their resources into marketing budgets and attempts to generate news hype. We automatically rule out investing in companies that promote themselves too aggressively, or do so misleadingly.
7. Only buy highly risky penny stocks with money you can afford to lose.
8. Understand that buying penny stocks is often pure speculation. It can pay off extremely well when it succeeds, of course, but that is uncommon.
9. You should be especially careful with penny mining stocks before investing. It is sometimes said that a single drill hole has a 1-in-1,000 chance of turning up an “anomaly,” or a drill result that could be a marker for a mineral deposit. However, the odds against finding a mine on any one anomaly are also about 1,000 to 1. So, the odds that a particular drill hole will lead to the discovery of a valuable mineral deposit are about a million to 1. That’s why we never recommend penny mining stocks that have much or all of their value riding on a single drill hole. Instead, we want to see a series of promising drilling results, along with other encouraging development work. Geographic diversity—more than one prospect in different regions—is a positive investment indicator for penny mines.
10. Apply our sell-half rule. Selling half your holdings after you double your gains is a good strategy for any high-risk investment, but especially so for penny stocks. This can give you a clearer perspective on what to do with the other half of your investment. After all, if you are too slow to sell speculative stuff, your profits and even your principal can evaporate all too quickly. This aggressive profit-taking style will help minimize penny stock risks.

If you lose money in penny stocks, you may think your main mistake was bad timing. That’s a misconception. Penny stocks are similar to casinos. If you play long enough, the “house odds” eventually triumph over any run of luck. In penny stocks or games of chance, the odds are against you. The longer or more often you play, the likelier you are to lose.

Which of our 10 strategies above have you used to minimize the penny stocks risks you’re taking? Do you have another strategy we haven’t mentioned? Share your experience with us in the comments.