Warren Buffett, the legendary “Oracle of Omaha,” is one of the wealthiest people in the world, having amassed a fortune of more than $70 billion since the 1960s.
Many people take investment lessons a from Buffett, and base stock-picking tips on his homespun attitude. Buffett is way too big to be investing in penny stocks — he only gets involved in mega-cap giants — but that doesn’t mean his methods and approach doesn’t hold lessons for penny stock investors and traders.
Here are a few Buffett staples that penny-stock investors would be wise to keep in mind:
Don’t Borrow too Much
Buffett is not keen on borrowing or leveraging money. If you’re borrowing capital in order to trade, you need to make up the interest on the borrowed capital, which could lead you to take unnecessary risks doing so. Although leverage can be a good thing at times, it could cause you to lose more than you expected to lose.
For example, let’s assume you short a stock on a margin account, you could lose a whole lot more than you expected, since theoretically, a stock’s price could run higher, and you’re borrowing securities from your brokerage firm in order to sell short a stock. Therefore, you would be taking on a lot of risk, if you’re just starting out, you would want to shy away from taking on too much leverage.
Try to Be Optimistic
Let’s face it, there are many things to be pessimistic about when the market is selling off. You might think the sky is falling if you’re in stocks when they’re experiencing a bear market.
Buffett, by comparison, takes an optimistic approach when it comes to bear markets. Rather than being afraid of them, he’s optimistic and excited about them, as they mean he can potentially get stocks on the cheap.
Limit Your Losses
Buffett has said he has two rules: 1) Never lose money, and 2) Never forget rule number one.
It’s pretty hard to avoid losses when you’re trading, particularly in penny stocks. But you can take steps to minimize your losses.
Always look long term and try to stay in the game for as long as possible. In other words, don’t let one position potentially wipe out your entire trading account. You should always focus on limiting losses, even if that means getting out and seeing the stock reverse. This balances out your optimism for the future, because you are aware of the risks along the way and living to invest another day.
These lessons aren’t only for those who follow a similar strategy to that of Buffett’s. They’re words of wisdoms that nearly any market participant can potentially benefit from when they’re trading.
Jason Bond runs JasonBondTraining.com and is a swing trader of small-cap stocks.