Minimizing Risks In Penny Stocks

To get an idea as to just how risky buying a Penny Stock could be, let's look at a worst case scenario, and then focus on how to avoid these types of situations. Seeing how high a stock has been in the past and how low it is today forces us to send an order through to our broker using half of our account value.

We noticed the stock because it skyrocketed today on high volume, and the press release that came with it makes the company seem unstoppable. We calm our nerves by telling ourselves we will sell the stock at a moments notice if it gets down to a certain level. The very next day the stock moves up a little bit more early in the morning, and we are euphoric, and even whisper that we can now sell the stock should it fall back down to break even, thereby making it risk free from here on out.

But this is not really an issue, because we are certain that the stock will not even go back down to those levels. Lunch time comes and volume slows to a standstill and you start to think about lunch yourself. When you return to the screen, you see a lot of activity on the Level II screen, and feel something is brewing; perhaps this is the big run.

The first few trades look good, but you soon comprehend that the stock is tanking fast, you are concerned but convince yourself that it must just be a shake out before the next peak. It has already fallen below your break even level and even below your point of no return. As you page through different time frames on your charting software, you quickly realize that your penny stock has now fallen back to where it was before the run began, and is even right near its all time low.

Instead of firing your sell order, you begin to hypothesis that if it was cheap when you first bought it, it must be at bargain basement levels now. You decide to use the rest of your account value to enter another buy order, and then quickly calculate how high the stock will have to go to break even. Solace is found in the fact that it is less than halfway between your two buy points, and you continue to hold for weeks, even months as the stock slides ever downward.

Perhaps the stock falls below a penny, and maybe you even scrap up a few more dollars to add to the position. Eventually, after trading between $.0001 and $.0002 for what seems like a lifetime, the company announces a 1 for 900 reverse stock split. After you find the new symbol and see your account updated, what seemed like a substantial position in the company has been reduced to a mere couple of hundred shares, but at least it is worth close to a dollar per share.

Over the next few days the stock plummets back to sub-penny land almost as fast as the pit in your stomach develops as you come to the devastating conclusion that selling the stock now would not even yield enough to cover the commission.