We are picking a stock and there is no need to time the entry or exit? That sounds like a value investor having a vision and buying a stock to hold it indefinitely. The fools from Motley seem to have invented such a thing lately. But this site is about trends. Obviously we have a different opinion. Stock picks are for trend trading. But there is a special case…
The smaller the stock the less liquid its market is. With lower trading volume comes a different pricing behavior. Technical analysis doesn’t work anymore, at least not as smoothly as it does with large stocks. If volume shoots up sporadically, it is clear that chart patterns have to look different. In times of low volume the stock price can easily glide up- or downwards without a real reason or meaning. The price will also disregard lines of support and resistance in such a mood…
Small stocks have a beauty and that is exactly this impossibility to trade them the normal way. That doesn’t mean that they can’t be traded successfully. It means that trading can be much easier than with bigger stocks. The more traders are there trading something the better is liquidity and the more efficient are markets. It is hard to trade liquid markets.
The best example is probably Forex. Many small traders get lured by blinking Forex robots into the currency market and then face an uphill battle against random prices. How much easier could be their trading life if they concentrated on small stocks instead…
The best penny stock trading method is to look for fallen angels. Stocks that came down from much higher highs. Trading is statistics. A beaten down price means that there is statistically potential for a huge price appreciation.
The statistical undervaluation gets exaggerated by the starving volume. Interest in the stock simply dries out and prices literally implode. In such a situation the only trading signal that is needed is a new flame of interest. Volume and price are reacting heavily, but the stock may be still grossly undervalued.
A seasoned small cap stock picker looks for situations like these, simply enters the stock without waiting for some exact buying spots and holds it from there on. The sell signal could be a severe drop in volume and price after some volatile trend upwards. Trend is meant here as a heavily zigzagging upwards move. The trigger to sell could also be a trailing stop. No, not twenty percent. We are after monster moves here. So, a trailing stop of fifty percent is more what we want.
Let’s make a short trading rules list:
Look for stocks the got hammered down and then faded into oblivion. Suddenly our trading candidate has to show renewed interest. Trading volume explodes and prices rise.
Hold until volume and price show that the excitement is over. A trailing stop of fifty percent is in the right ballpark.
Actually this is a trading system for penny stocks and other small caps. But it is extremely simple. The emphasis is clearly on item number one. The stock picking process is the important part.
Why does this work? It is the above mentioned undervaluation that gets exaggerated by a longish starvation period of a stock. There are other setups, but this is the principal plot. In the small cap markets stocks can easily become ultracheap. The outcome is a price potential of often thousand percent. If things don’t pan out as hoped for, the maximal possible loss is hundred percent.
It is this asymmetry that small cap stock pickers should be looking for!
One good idea for the stock picking part is to use a good stock picker as a source of trading ideas. Trust is important here, as these markets are prone to plays of pump and dumpers.
So, here is our recommendation. A small cap picking service with about five different buy setups. They all try to focus on stocks that are on the brink of coming out of the Hades. Don’t expect hit rates of fifty percent or above! You are aiming for monster gains and not for many small gains overcompensating fewer smaller losses.
Too hot for you? Then try the Zen Trade’s stock picks for larger stocks (RSS icon is in the header). But you have to be able to trade these, which is much more difficult than using this simple 3-step penny stock trading system above.