Staying away from the most volatile penny stocks will help you build a more stable and diversified portfolio of higher-quality stocks

Some investors look to the most volatile 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.

The Successful Investor philosophy recommends that even those who want to invest aggressively should choose stocks with as much underlying value and as many hidden assets as possible. This is the best way to cut risk, for aggressive and conservative investors alike.

Look for high-quality stocks instead of the most speculative and most volatile penny stocks to gain more from your portfolio over the long term

Investors looking to add to the aggressive portion of their portfolios may turn to the higher-risk strategy of buying speculative penny stocks.

However, there are several potential risks when investors venture into these penny stocks.

Buying low-quality penny stocks is one of those things that can appear to be successful before it goes badly wrong. Some get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than high-quality stocks.

If you lose money in speculative pennies or other low-quality stocks, you may think your main mistake was bad timing. That’s a misconception. Almost all penny stocks rely on luck to become wildly profitable. If you play long enough, the “house odds” eventually triumph over any run of luck.

In penny stocks, as with games of chance, the odds are against you. So, time works against you. The longer or more often you play, the likelier you are to lose.

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Avoid the most volatile penny stocks and when a bubble bursts your money will be safer

When the bubble bursts in an industry or sector, the most volatile penny stocks are typically the quickest to fall. Some investors get hooked on the possibility of high profits in a short time frame, but it’s important to remember that penny stocks are far more volatile than the stocks of well-established companies. It’s far easier to launch a stock promotion to make quick start-up cash, but it’s much harder to nurture that start-up into a successful, long-lasting business.

This volatility is why we recommend that penny stocks only make up a small portion of an overall investment portfolio, if any, preferably bought with money that you’re willing to risk. In addition, penny stocks are best suited to investors who can accept substantial risk and can cope with the potential highs and the inevitable lows of risky investments in their portfolios. If you’re wrong on a speculative stock, your losses are likely to be larger than any losses from your more conservative selections.

Only invest in the most volatile penny stocks with money you can afford to lose and your portfolio will remain more stable

When you buy penny stocks you could have a big payday if you make the right choice. But the odds against 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, launching new software, and so on.

In general, penny stocks have lower trading volumes or liquidity, and this lack of liquidity means it may be more difficult to sell a stock when you want to. They also suffer from large price fluctuations, so any bit of news can cause a penny stock’s price to rise or fall.

Ultimately, penny stocks should only be a small part, if any, of any diversified portfolio. You should only buy the most speculative of them with money you can afford to lose.

Sell your most volatile penny stocks if they announce a major partnership; then you’re more likely to hold onto your profits

Sometimes a penny stock will announce a deal with a major company and its value will increase dramatically. When this happens, it’s often a good time to sell. Also, if one major investor sells, trouble may be on the horizon—it can cause an abrupt price slump, making it difficult for even the most promising of start-ups to attract additional potential investors. This is especially true if the stock is a “thin” or “illiquid” trader because it doesn’t take much buying and selling activity to influence its price. Time is not on your side when investing in penny stocks—the longer you stay invested in volatile stocks, the more likely it is that you will lose not only your profit, but your principal as well.

Use our three-part Successful Investor approach to make the best stock picks

1. Hold mostly high-quality, mostly dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

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