One of the biggest problems with penny stocks is that they attract gamblers. The exponential spikes in share prices and popular success stories give people a rush that fuels a “get rich quick” mentality. If you see a stock that rises 1000% percent in a few weeks, you begin to think “If I put $10,000 in that a week ago, I would have $100,000 right now.” I’m guilty of this myself. It’s an interesting observation, and completely harmless as long as it remains a mere observation. The problem comes in when you try to chase those opportunities. Sure, those gains are achievable, but they aren’t very probable. Nonetheless, the desire for fast wealth leads many traders to ignore all reason and trade based on greed. Ignore this at all costs. You’d be better off blowing your cash on scratchcards or putting your life savings on red in roulette at the nearest casino.
I use a very basic mental strategy when I enter a high-risk trade: be prepared to lose your entire initial investment. This is not to say that you shouldn’t get out of a trade until the stock drops 100%. Do your research and know where you want to get in and out of the stock, but also plan for the worst. Penny stocks are extremely volatile and prone to large dips and spikes. Some stocks even get pulled from the market, leaving investors empty-handed. Realistically, you should never get close to losing 100% of your initial investment, but you should trade as if that were a possibility. Think of the ramifications of losing your entire initial investment. Could you still pay your bills? Would you still have enough funds to trade and grow your account? What would that loss do to your trading confidence?
Imagine that you find a stock that you believe will rise 1000% over the next few weeks (I’m using such a high number because penny stock traders dream big). Sure, putting $10,000 into a stock may not seem like a bad idea if you are focused on a gain of close to $100,000, but what if you were to lose that initial $10,000? Even if you only lost 50% of your initial investment, you would still be down $5000, and that can take a toll on a lot of people’s portfolios. Don’t get blinded by shiny gains; manage your risk properly by paying attention to losses. You may instead want to consider a $1000 investment that may yield a $10,000 return. This limits your risk and still allows you to profit if the stock moves as you foresaw. Of course, the numbers mentioned above are extreme examples, as 1000% returns can be difficult to achieve, but the concept remains the same when applied to gains and investments of all sizes.
