Ten simple rules for maximising your penny share profits

Penny shares © iStock
Over the long-term small-cap stocks have performed extremely well

Hunting down good penny shares is one thing. Choosing the best time to invest in a penny share is quite another.

We always hear about the importance of “buy low, sell high”. And it’s a good point to bear in mind. But let me be clear right away: it doesn’t matter how much research you do, it doesn’t matter how many years you have under your belt – the reality is that it’s almost impossible to buy at the lowest possible price and sell at the very top. You’ll be lucky to manage it once in your investing career, let alone every time.

But that’s not the point. We’re investors, not crystal-ball gazers. And by following these ten simple rules, you can be sure that you are doing all you can to maximise your profits from penny shares.

1. Build your position in penny shares slowly

So you’ve found a share you like. Rather than diving in with all your money, start small. Buy perhaps no more than half of what you expect your eventual position size to be. Why do this? Staking even a small amount of money on a share will make you pay more attention to the factors that might affect the company. In time, you will either grow more confident in the investment case, or you’ll start to think it’s the wrong thing to do. That will put you in a better position to decide whether to buy more shares (and when to do it). However, do make sure that your decision is based on the progress of the company, rather than movements in the share price.

2. Don’t panic if a share price falls

That takes us to a second key point. If the share price of a company you hold starts to fall, you need to find out why. It may indicate that there’s a serious problem there, one that might affect your reasons for buying in the first place. So pay close attention to what the company says, and feel free to engage your gut instinct – often the tone of a press release or announcement says as much as the actual content itself.

However, don’t panic just because the price is falling. Share prices can fall (or rise) for several reasons, many of them totally unrelated to the actions of the company in question. So a falling share price doesn’t necessarily suggest a company is broken beyond repair – indeed, it’s quite possible for the price to fall for no particularly good reason. So as long as you are staying diligent and following the company’s progress and you are satisfied with it, hold your nerve.

3. Don’t waver on buy limits…

It’s important to avoid paying too much, even for a good share. It’s unpleasant watching a share price ticking higher, feeling you’ve missed out – but it’s even more painful to jump in and pay too much, then watch the price start to slide. So if an instrument looks attractive, decide how much you think it’s worth, taking into account its holdings, prospects and risks. Give yourself a target price – a buy limit – and don’t exceed that price. Only revise your buy limit if the information genuinely changes.

4. …and the same goes for selling

Trading shares is a form of negotiation. When you sell – just as when you buy – you don’t want to trade for anything less than the best possible price. Decide how much you think the share is worth, and only sell when your demand is met. Don’t allow yourself to be lowballed.

5. Don’t use stop losses

This might sound odd. Stop losses are often seen as crucial for investors. But in fact they can be as much of a hindrance as a help. For a start, a stop loss can get you kicked out of a share at the wrong moment, particularly when investing in a more volatile sector such as penny stocks. It’s very unpleasant to get thrown out of a position only to watch the share turn around and do exactly what you were hoping, only without you on board.

And feeling the need to place a stop-loss on a share raises questions about why you are buying it in the first place. At the end of the day, this is investing, not gambling. Yes, there are good reasons to sell – you may realise that your initial investment case was flawed, or things may not turn out the way you want them to. But in that case, the reason to sell is because you got it wrong, not because the share price has hit some arbitrarily chosen trigger point. The point is, if you’ve placed a stop-loss, it suggests that you don’t have faith in your assessment of the company. And if you don’t believe in your investment case, then why risk your capital?

6. It’s fine to take some profits

You may buy a share with a target price in mind, but you shouldn’t be <em>too</em> inflexible. Say you buy a share at 8p with 25p as your target price. If the share moves to 20p, it might make sense to sell some of your shares and bank some profit. After all, life and stock markets are never predictable. In this case, you’ve made good money and while you might expect to make a bit more, the share is clearly not as cheap as it was to begin with, unless there’s been some major, game-changing development.

7. Keep an eye on trading volumes

Individual penny shares are often very cheap, but they can be illiquid – in other words, they may not trade particularly regularly or in large quantities. So it’s worth keeping an eye on average trading volumes – you can find this on most investment data websites, such as Yahoo Finance or Google Finance. The higher the volume, the easier it will be to buy larger quantities of stock without moving the price drastically.

8. Diversify and rebalance

No investor should place all their eggs in one basket, regardless of their strategy. But diversification and regular rebalancing is particularly important when dealing with penny shares, which tend to be more volatile than most assets.

Say you invest £10,000 equally between ten shares. One share rises five-fold; the others stay more or less as they are. Your portfolio is now weighted strongly towards your star share. But it’s already risen hugely in value. At that point, it probably makes sense to sell out of that share – at least in part – and divert some of your cash into your other shares. If you’re pondering whether to do so or not, just ask yourself – if you were buying in now, would you really want to have nearly a third of your entire portfolio invested in that one share?

9. Don’t trade for the sake of it

Every trade – whether buying or selling – will cost you money. You’ll pay dealing charges, you’ll lose out on the bid-offer spread, and on some shares (though not on Aim) you’ll have to pay stamp duty. So don’t trade more than you need to – manic buying and selling is a sure fire way to erode your returns rapidly without even noticing it.

10. Don’t be too hard on yourself

It’s going to happen. At some point, you’re going to buy a share that doesn’t work out for you. And like every investor in history, you will make some duff trades – you’ll second-guess your own carefully laid plans, and you’ll come a cropper. Don’t beat yourself up about it too much. It happens to even the most successful investors – it’s inevitable. Don’t worry about it, and don’t lose heart. All that matters is that your profits outweigh your losses over time. And by following these ten simple rules, you should be able to achieve that.