Some penny stocks may look promising to penny stock investors, but they need to know how to spot the winners

Investors often try to improve their investment returns by delving into high-risk and/or high-fee investment areas such as specialized investment products, options, penny stocks and so on. Far better to start off by putting yourself in a position to profit from human nature, rather than suffering because of it, as you often do in high-risk investing.

That’s why it’s important for penny stock investors to approach any penny stock with a healthy dose of skepticism.

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Straight talk on penny stock advice for penny stock investors

Penny stocks can be riskier than other investments and early success can (paradoxically) actually lead to a big loss.

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.

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 or launching new software.

The longer penny stock investors play, the likelier they are to lose

If you lose money in speculative or other low-quality stocks (or ETFs that invest in low-quality stocks), you may think your main mistake was bad timing. That’s a misconception. You can get lucky in penny stocks, just as in lotteries. But 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. So, time works against you. The longer or more often you play, the likelier you are to lose.

That’s also why we think you should apply our sell-half rule.

Selling half your holdings after you double your earnings 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.

The reality is it’s easier to launch a promising company than to create a successful business. That’s why only a minority of penny stocks ever go on to significant success. And while penny stocks can be a worthwhile addition to the aggressive portion of a diversified portfolio, you should in general only buy them with money you’re willing to lose.

Getting out of bad investments for penny stock investors

Many investors try various ways of eliminating losing stocks from their portfolios. These efforts often backfire. Some lead you to sell stocks that had already fallen a great deal, and are ripe for a rebound. Others lead you to switch into better-performing groups, just when these groups may be on the verge of joining in the plunge. Worst of all, some may lead you to give up on the market altogether and “go into cash,” just when the entire market is close to a bottom.

If you discover 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.

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.

If you’re the rare breed of penny stock investor, what do you disagree with above?