Most less experienced traders of penny stocks buy and sell all at once. They have $3,000, they find a penny stock they like, and they put all $3,000 into that one investment. This isn’t necessarily a wise trading tactic, and as anyone who knows my story understands, I learned this lesson the hard way when I first started out.
More advanced traders of penny stocks have a more effective strategy. They scale in and scale out of their positions. Simply put, the $3,000 in our example would be invested in 2 or 3 or even 6 chunks, and these buys would happen over days, or weeks, or months.
When trading penny stocks, you should always Scale In, and when selling penny stocks, you should always Scale Out.
Let’s say you have $6,000 and want to invest it into ABC Company. Instead of putting $6,000 into the company immediately, you only invest $2,000 at first.
If that penny stock starts going higher, the two thousand dollars is in a profit position. If it starts going lower, at least you’ve saved the loss that the other $4,000 would have taken. At that point, if you still believe in the investment, you could Average Down by buying more shares with the $4,000 that is still on the sidelines.
This strategy has even been employed in turn of the century military tactics. A good general always holds back some of his troops, and can then respond based on the results of the first attack.
By Scaling In, you stay dynamic and keep your options open. It also buys you time. Time to think about the decision you made, and maybe rethink what you are doing with the rest of the money. It also allows you to watch as other events occur, while still having the option open to buy more shares.
For example, you might Scale In with a buy in February and come back with a secondary purchase in July, and a third in September. In between each of these purchases, you have time to assess the situation and see new events that occur with the company, with the competitors, and with the overall market and industry. You will simply be more informed.
It also keeps your money on the sidelines so that you’re open to other ideas. For example, say you were going to put $6,000 in ABC company, but instead you decided to scale in, and you held $4,000 back. Then perhaps another opportunity comes to light, or maybe your kid needs braces so you use the money for the orthodontist. The downside to Scaling In is that your broker commissions will be higher, but that’s not really a big deal since most stock brokers charge such low commissions.
When you’re selling penny stocks, you may want to Scale Out. It’s not usually a good idea to dump all your shares onto the market all at once, unless you only have a very small position in the company. With thinly traded penny stocks, unloading even 25,000 shares could push the stock price down while you are selling.
A lot of people use the very common, and somewhat effective strategy, of selling half of a position if their investment doubles. This gives you back your original investment, and then the idea is to let the other half ride. I find it more effective to exit and enter positions in three, four, or even eight different trades, as long as you are doing it with enough money each purchase to make it worthwhile. I usually space these purchases out over months, and sometimes years.
I bought Absolute Software at 80 cents. It scared me by immediately going down to 40 cents, but Leeds Analysis provided clarity on this stock’s direction, so I didn’t worry.
Soon Absolute reversed, and within the next two years approached $8.00 per share. I sold three different chunks around seven and eight dollars, over a couple of months. Rather than dumping all the shares at once, I proceeded cautiously, and took my profits a piece at a time.
It’s also a good idea to Scale In or Scale Out surrounding an event. For example, a company is going to release their financial results, and you expect the numbers to be strong. You might want to buy shares with part of your money before the release of the financials. Then you keep part on the sidelines, until you see the actual results. At that point you can decide if you want to put the rest of the money in, or perhaps now you’ve changed your mind.
Peter Leeds is the Penny Stock Professional. Along with his team, they publish various penny stocks, buy and sell prices, daily updates, and special feature reports.