Blog : Setting Loss Limits in Penny Stocks You Buy

by Peter Leeds on June 22nd, 2012

In this market environment, where even the best penny stocks you buy are seeing their shares under pressure, it makes sense to revisit a concept of protecting yourself from the downside.

This is NOT trading advice.  This is merely opinion, explaining a concept that some people may have applied to their benefit possibly.  Read it as such, and always make your own trading decisions and take responsibility for them.  Setting Loss Limits in Penny Stocks You Buy is for entertainment purposes only.

The most important thing in stock investing is preservation of capital.  In other words, avoid taking significant loses in stocks, or any individual stock.  Live to fight another day.

Think about your own stock investment portfolio.  What if all the losses you ever took in stocks was confined to (at most) 10% of your total investment money?  Stock market gains could be unlimited, but stock market losses would be capped at 10%.

Even with 5 horrible, calamitous trades in a row, a $1000 initial portfolio value would only drop to $590.  In other words, even with 5 terrible buy trades, one after another, and no wins in the time frame, you would still only have lost about 40%.

Here's the math:  

You buy $1,000 of stock #1.  It drops 10%, so you sell.  That's $900 left.

You buy $900 of stock #2.  It drops 10%, so you sell.  That's $810 left.

You buy $810 of stock #3.  It drops 10%, so you sell.  That leaves $729.

Stock #4 drops 10%.  You sell, taking your remaining $656.

Stock #5 drops 10% (or $66).  You sell, and have $590 left over.

Keep in mind that in penny stocks, even in a brutal market like this one, it is very rare to buy 5 losing penny stocks in a row like that, and without any winners.  (Unless, of course, you are following someone else's promotional, unethical penny stock picks, in which case you can lose a lot more often).

The secret is in having nerves of steel.  Being devoid of emotion.  Never falling in love with an individual penny stock or it's company, product, or service.  

It's a simple tactic.  If ANY penny stock you buy drops 10% from your initial buy price, you immediately sell all your shares.  No ifs, ands, or buts.

What happens then is often that the penny stock keeps sliding... at which point you can always buy back in at lower prices.  

Sometimes, of course, that penny stock will have fallen 10%, inciting you to sell, then it pops back up to previous prices and beyond.  That's called getting 'stopped out,' and in cases like that you will have taken a 10% loss on a penny stock that you buy, only to see it soar to new heights after you sell.

Avoid allowing the possibility of missing out on a stock gain deter you from what is a sound and logical capital preservation approach.  If your biggest losses in penny stocks are limited to 10% of the penny stocks you buy, you will have plenty of time to find more penny stocks and penny stock picks to buy with magnificent upside.

There are lots of free tools online (such as at Yahoo! Finance, MarketWatch, and through your broker) where you can set text/e-mail alerts for any time the penny stock you bought, or any penny stocks you are watching, hit certain price targets.  For example, a 10% decline from where you first buy the penny stocks.

As most penny stock and discount brokers don't allow you to set up automatic stop loss orders on certain penny stocks, you probably will want to take care of any sales of your penny stock picks manually.  Meaning watch the penny stocks you've bought, and if they hit a decline of 10%, immediately sell the shares if that is the approach you decide to emulate.

Looking back at all the penny stocks you've purchased in the past, many of the penny stocks you buy will have dropped 10% from their buy price at one point or another.  Some of those will have kept right on sliding (especially in this market), a few of which may have recovered.

The point is that no matter what the underlying price action of the penny stocks you buy, your capital will get preserved, and you will avoid long, extended losses in the penny stocks you buy.