If you decide to start trading without professional advice, you'll have to find and research penny stocks and determine when to buy and sell on your own. If you want to do your own thing, you need to familiarize yourself with some trading techniques to help you with this task.
"Timing means everything" in trading penny stocks. Anyone can look around the market and find skyrocketing stocks, but a good investor needs to find them before they rise. This page offers you some basic methods to narrow down your search for investment gems.
Technical Trading | Day Trading | Momentum Trading | Swing Trading | Scalping
Technical Trading
Technical analysis creates the foundation of all trading, stock identification and your investment entry and exit points. The technical trader examines charts to find the trading history of a stock, observe indicators and identify price patterns and trends. Technical trading consists of complex mathematical processes, and technical traders make good money for doing what they do. We can't summarize tech trading easily, but we'll do our best.
Main Technical Indicator Groups and Analysis Methods:
Strength Indicators/Oscillators compare present price action to the prices in the stock's history and show the strength or weakness of the stock. The relative strength index (RSI) is often shown at the top of a chart. The RSI can indicate overbought or oversold price conditions and tip traders off on whether to buy or sell. It is calculated using this formula:
RSI = 100 – 100/(1 + RS*)
*Where RS = Average of x days' up closes / Average of x days' down closes.
The RSI ranges from 0 to 100. An asset is deemed to be overbought once the RSI approaches 70, meaning that it may be getting overvalued and is a good candidate for a pullback. Likewise, if the RSI approaches 30, it's an indication that the asset may be becoming oversold and is therefore likely to become undervalued.
Moving Averages indicate trends by averaging historical price levels over a certain period of time and can identify short term price movements above or below long term price averages. Crossovers occur when the price of an asset crosses through a moving average, or two moving averages cross over each other. They offer traders an indication of the possible breakouts or breakdowns in the stock price. Some crossovers indicate more than others. The "Golden Cross" crossover identifies a short term moving average increase compared to a long term moving average. The opposite of the Golden Cross is the "Death Cross."
Pattern Analysis evaluates the stock chart and identifies price formations or shapes (triangles, wedges, head and shoulders, etc.) These formations can indicate potential upward or downward movement in the future. Market forces cause these formations and their occurrence often affects trading and price action. Market manipulators can attempt to draw the chart and create a favorable movement.
Range Analysis uses the opening and closing price ranges to identify a stock's support and resistance levels. These ranges offer a valuable tool in determining the best buy and sell points as well as potential breakout or breakdown levels.
Gap Analysis finds gaps in the charts during a certain time period (day, week, etc.). The difference between the previous period close and the price at the beginning of the following trading day causes gaps in the chart. In the case of penny stocks, the gaps almost always fill unless the company proves true success that sustains the price movement. Gaps can determine buy prices or re-entry targets, as the price will likely return and fill the gap before moving higher.
After you identify an attractive stock to trade with technical analysis, use other methods to support your stock choice and times for buying, selling and holding the stock. You should always use Level 2 quotes to refine your buying and selling decisions and monitor a company's news and filings to protect your investment from fundamental changes within the stock. Level 2 quotes, the list of all bids and asks, are powerful tools that allow you to analyze whether a stock goes up or down at a particular time. Investors usually use online data service providers.
Why to Choose Technical Trading
As you'll need to start scanning online forums and message boards for your golden stocks, you'll most likely encounter some professional technical traders. They may help you to identify hot stocks and you may learn about technical trading from them. Technical trading offers the only possible analysis to judge a penny stock and its price movements.
On the other hand, the mathematical complexity of technical trading can make it difficult to comprehend to those without the proper training or capacity. Use the Internet to explore the many sites that focus on tech trading. Pumpers and bashers often target penny stocks and may deceive inexperienced investors into buying or selling as they draw charts and make them look positive or negative.
Day Trading
Day trading focuses on buying and selling a security within a single trading day, usually several times with one or more stocks. Day trading doesn't refer to a specific strategy, just the length of time that traders hold the stock. Day traders live on the edge at all times and are prepared to lose the money they invest.
Successful day traders must have skills, resources and a mindset of steel to succeed because they can make and lose fortunes quickly. Day traders need a successful mindset and must keep emotions completely out of the equation while making their investment decisions. They use their skills and knowledge alone to quickly cut losses and maximize profits. The trader hoping for a recovery as a stock drops will most likely lose more money than the trader who cuts losses early and moves on to find the next profit. Many inexperienced traders enter the market as day traders only to see their investment dissolve. We recommend starting out slowly and learning as you go. When you see that you profit consistently, you may try and day trade.
The day trader must have knowledge and experience in the marketplace, sufficient capital and a strategy. Day traders incorporate strategies such as momentum, fundamental or technical trading to find and profit from stocks.
Before considering day trading, investors should know the definition of the term "pattern day trader" (PDT). The Securities and Exchange Commission (SEC) defines individuals as PDTs when they buy and sell one or more stocks at least four times on the same trading day throughout a five-day period. The individual's same-day trades must also make up at least 6% of his or her activity during that five-day period. For those who day trade, that activity will far surpass 6% of their total activity. You'll need a minimum broker balance of $25,000 for the brokerage to let you day trade. Without that, the brokerage will suspend your account for 90 days or until the balance returns to the required minimum.
Day Trading Pros:
- Short holding time minimizes the risks from fundamental changes in a stock or company.
- Potential for large profits when multiple profitable trades made in one day.
Day Trading Cons:
- Inexperience and the inability to contain emotions can lead to substantial losses.
- A large account balance required to pattern day trade.
- Since pattern day trading requires a margin account, you may be tempted to risk more money than you have.
Momentum Trading
Momentum trading strategy focuses on profiting from stocks that move quickly on upward momentum and have high volume. Penny stocks usually gain momentum because of a buzz via expected news, filings or online rumors. Momentum traders need to monitor stocks for a buzz on message boards and forums. You can always find several stocks getting a lot of attention, which signifies that traders will play the stock heavily in hopes of driving the price in one direction and profit before the party ends.
After you've created a list of stocks with a buzz, research and watch their trading activity before buying in. Stocks with momentum potential have higher than average volume and move in the opposite direction or higher than the general market. Confirm the momentum by watching price action, Level 2 quotes and charts. Several technical indicators show building momentum, including the momentum indicator, moving average convergence divergence (MACD), relative strength index and on-balance volume (OBV). Momentum trading also relies heavily on technical analysis. Monitor the Level 2 quotes to spot a building bid, or offers on the ask price disappear. This is the first sign that a move could occur.
Once you confirm the momentum, buy quickly at the best asking price (with big orders, you may buy a little above average to secure your bid and a fast fill). Once the stock is purchased, the trader needs to constantly watch and scan charts and company news. If any negative indicator, trend or news develops, consider a quick sale to cut losses and move on. If the momentum continues and your stock starts profiting, keep it and watch your charts and Level 2 screen. When offers on the ask price start to pile up or bids start to thin out, take your profit and move on. The stock may continue to rise after a breather, but it's always a smart move to take any profit while you can.
Momentum Trading Pros:
- Plenty of penny stock forums and message boards to scan for buzz and find hot stocks.
- Penny stocks move the fastest and, when momentum builds, it may lead to huge profits in very little time.
Momentum Trading Cons:
- Volatile penny stocks may only give an extremely short selling opportunity.
- Hype-makers fill forums and message boards while pumping up stocks and orchestrating momentum runs.
- Companies with a dilution agenda can post negative news and stall any momentum.
Swing Trading
Swing traders search for stocks that have potential to move in a relatively short time period of one to four days. This approach is mainly used by day traders and those who trade from home. Swing traders focus on price trends and patterns rather than on actual stock value.
In a market suitable for swing trading, stocks tend to trade above and below a baseline moving average or exponential moving average (EMA). Penny stocks typically use moving averages as both support and resistance levels. Educated traders buy close to a bottom level moving average and sell before the top level, or target moving average. Traders may leave some profits behind, but significantly cut their risks.
Swing Trading Pros:
- Swing trading offers a great initial experience for a beginner.
- Even swing trading doesn't aim for the top prize; a swing trader can profit immensely if catching the start of a new uptrend.
Swing Trading Cons:
- It's hard to find a perfect market where the stock will trade between its support and resistance levels, and the situation may be complicated if a stronger uptrend or downtrend comes into play.
- Penny stocks make it difficult to time your buys correctly. If you hold the stock while it goes through dilution, you may have to wait to sell until the dilution ends.
Scalping
Day traders, as scalping is a form of day trading, may scalp profits by making several trades a day and generating a small profit on a stock that either isn't moving or is moving sideways. Scalpers use the bid/ask spread to their advantage. Buying shares at the bid, scalpers can try and sell at the ask price to make a miniscule profit. If scalpers can repeat this several times (or trade a large number of shares), the total profit can add up. This strategy can sometimes work well with penny stocks, but it doesn't have a chance with most others.
Scalping Pros:
- Penny stocks often have a large percentage spread which can lead to decent profits.
- Penny stocks often trade sideways.
- By buying at the bid and immediately selling at the ask, you get in at the lowest price and reduce your risk by holding shares for the shortest period of time.
Scalping Cons:
- Penny stocks can have very weak volume, making it difficult to buy at the bid and sell at the ask price.
- You're working against the market-makers, so don't forget that the house makes money first.
- Due to the small profits and high risk of penny stocks, other strategies suit most penny stocks better.
