By Eliza Stuart /

Six Basics of Penny Stock Trading

Penny stocks, also called cent stocks in certain countries, are common shares of small companies that trade at very low prices per share. There is hardly a shortage of such companies, but to be successful, you need to create a penny stock investing plan, and that includes following the most basic rules every penny stock trader should observe.

1. Use limit orders at all times.

Penny stocks are very thinly traded due to their very nature. Thus, the deviation between the bid and the ask is often substantial. Investors who use market orders could be played by market makers who just want to make a quick buck. To keep the market maker from buying or selling at any price, limit orders must be used. This means your terms, not the market makers’ terms, will be used when you buy or sell penny stocks.

2. Keep within regular trading hours.

When there is an absence of volume, the result could be after-hour trades that are nonsensical and most surely do not represent an efficient buyer and seller match. With penny stocks, even a few pennies can make so much difference. By trading within regular hours, you can ensure an efficient trade.

3. Avoid chasing performance.

For some reason, investors sometimes decide to buy only once a stock has moved higher. When a stock flies, these investors believe the environment is safe for them. They may be wrong. Usually, by the time they think they’re safe, the opportunity has left and the losses arrive. What’s actually safe is to stick to new recommendations and the accompanying buy limits.

4. Limit your holdings to 20-30 positions.

This one is a golden rule. You can achieve maximum gains with a portfolio that consists of 20-30 positions. More than that and you get a dilution of returns. Lower than that means a performance that lags significantly. Worse, if you get too few stocks, you get the risk of huge losses.

5. Have a reason for trading.

It’s fine to own a stock that already has already moved up in value provided you have a good reason for doing so. “You can call these reasons “triggers. There’s no taking off for a stock without a trigger.

6. Expect a holding period of 90 days at average.

Lastly, keep in mind that penny stocks are extremely volatile creatures that can rise and fall any minute. Large gains may be expected up to a 90-day maximum. If that move does not happen, take the next opportunity. Sometimes, you’ll have to go back and forth with a single stock due to its volatile nature. Don’t expect rapid-fire day trading, but if you believe a stock’s value is going down and vice-versa, don’t think twice about selling it.

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