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It is a well known adage that there is no free lunch: translated financially, that for every extra percentage point of return an investor gets, he has taken on comparable extra risk. This is truer than ever especially when it comes to small cap stocks in general and micro cap or penny stocks in specific. Yet, just like risk management is used even in the investment management of large cap stocks, the same technique (with requisite adaptations) can be applied to the micro cap or penny stock universe. Actually, in the smaller cap stocks, risk management is arguably far more important as the bad picks can really underperform and never come back.
Diversification is most commonly quoted as the first defense against the risk inherent in a stock portfolio, or, in this case, concentration risk. This can vary from a recommendation of holding thirty stocks to owning an index. In the case of micro cap and small stocks, though, one has to be wary of following this advice blindly as over-diversification (there are over 5000 small cap stocks!) will never end up in the triple digit returns sought by investors in penny stocks.
While the number of small to micro cap stocks to be held in a portfolio is not written in stone, one can say with certainty that any newsletter advising too many stocks at a given time does not understand how to truly benefit from the tremendous growth opportunities available in penny stocks. Not unlike a Venture Capitalist, the insightful newsletter writer will guide his subscribers to a relatively small portfolio that he will trade aggressively to allow room for newer opportunities without diluting the outperformance of the winners. Again, like a Venture Capitalist, a significant part of the returns will come mainly from 20 to 30%, and the underperformers will be methodically let go of. Beware of the newsletter or any online system that proclaims all their investments return double digit returns! For a good example of a newsletter that finely manages without giving up on rewards, see http://www.hypergrowthstock.com.
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