Penny stock investing is never easy at the best of times and there are some things that you should keep in mind if you decide to go ahead. To start with, make sure that there is some basic quality in the stocks that you are considering. You should look for strong fundamentals, quality of management and competitive advantage as well as a business plan that makes sense. The best way to find worthwhile penny stocks is to do your own analysis and research as far as possible. This would take a lot of work but the result will be worth it… If you are relying on outside analysis and advice, make sure that you use professionals who have no personal axes to grind.
The next thing is to learn some concepts that will teach you what not to do. Though used by many inexperienced investors, you should avoid averaging down at all costs. Novices tend to buy stock and then buy more as the price drops. To be sure, this brings down the average cost of acquisition but have you ever stopped to think that this may amount to throwing good money after bad. The approach may work with high-quality stock but it’s extremely speculative when it comes to high risk investment To give you a concrete example, you buy 1000 shares at a price of two dollars and a further 1000 shares as the price drops to one dollar. You now have 2000 shares at a total investment of $3000 which gives you an average cost of $1.50. You are already looking at a loss of $1000 at current market value of one dollar per share.
There are several problems with this approach. You may have made a mistake in your original choice and are now compounding that with a further investment. The second problem is that the share is trending downwards and something dramatic has to happen for the price to bounce back even to just cover your total investment. Realistically, this is not going to happen and you are merely pumping in more money into a ship that is already sinking. Moreover, as the example shows, the maxim of prudent investing is to minimize losses and preserve trading capital and averaging down does precisely the opposite.
The other thing that you should always keep in mind in trading penny stocks is to use your trading capital as efficiently as possible. You may not be fully aware of the reality of trading mathematics. If you own a stock that has dropped 50% in value, you need to see a recovery of 100% in value just to break even. If the drop is 75%, you need a recovery of 300% just to get back to your starting point. Naturally, the best way to avoid this situation is not to get into it in the first place. We all make mistakes and make losses some of the time. The only way to minimize your losses is to bite the bullet and get out of the position otherwise you may well be staring at a much larger loss.