Jumping into the world of stock trading, and more specifically, penny stock trading, can be a daunting task. The following is intended to provide a springboard for those who may not know where to begin. Click on linked terms throughout this article to bring up their definitions.
Okay, first thing’s first- You’re going to need a trading account of some kind, and access to trading data. You can retain a private broker, and should if it is feasible for you, but most people nowadays handle their penny trading via online platforms, of which there are a plethora. A quick search online will reveal which have the best combination of service, fair commission fees, and sometimes sign-up incentives.
Whatever route is ultimately chosen, you should always have access to a data subscription, a platform complete with full charting ability, instant order execution, and most crucial of all, real-time Level II Quotes.
Level II Quotes allow you to view the depth of the market on each stock, for example: The number of buyers on the bid, and sellers on the ask, and the prices at which they are bidding and selling. The bottom line: it is extremely difficult, and inadvisable to trade penny stocks without access to real-time Level II Quote data.
There are a number of ways to obtain Level II Quotes but one that comes the most highly-recommended is EquityFeed. EquityFeed is fairly expensive, however when used properly, can be the most effective implement in a trader’s arsenal. It also features a news ticker, to keep you instantly informed of any new developments that can have an effect on your portfolio. We don’t get anything if you sign up, we simply recommend this service because it’s widely considered the best available for this application.
About Penny Stocks
Over-the-Counter Stocks are very different from stocks that trade on higher exchanges. There are instances when a single trade can have a significant impact on the price of a stock. Penny stocks are highly risky ventures, and are not always for the faint-of-heart. To alleviate some of that pressure, one thing you always want to see in a stock is liquidity (high volume of shares traded). It is then that investors have a good chance to make timely entries, and profitable exits.
It can be difficult to find companies at this level with genuinely effective business models, and a lot of cash on hand, which is why most penny stocks are considered speculative in nature. Penny stocks are not generally long-term investments, and more for rapid trades that net quick gains. That being said, it is very possible, using the proper techniques, a cool head, and a lot of experience, to make substantial profits in just a short amount of time.
Some of the things that cause a penny stock to increase in value rapidly are press releases, promotions, positive buzz/rumors within the investment community, and favorable financial reports/filings.
Things that can have a negative impact, are insiders on Wall Street who have been known to manipulate stock prices, people who make money shorting stocks (betting that a stock will go down), and companies that suddenly dilute their own pool of stock by increasing the number of outstanding shares without adding value to the company.
It is impossible to predict what a penny stock will do all of the time, given all of these potential pitfalls, but a smart trader can still get in and out with a profit even in the most hectic of markets. A stock might explode at the drop of a hat, and fall through the floor just as quickly. Doing your own due diligence (DD) on a stock is helpful and 100% recommended, but in the world of penny stocks, to succeed you must acquire a knack for sensing trends and recognizing telling chart patterns. There is no short route to this understanding, but absorbing the following information can be a good start.
Gaining a Basic Understanding of Stock Charts
This portion assumes very little understanding of chart reading and terms, and its crucial patterns and indicators on the part of the reader. We realize that many of our followers are much more experienced, but relax, this is mostly for newcomers!
Keep in mind, there are many formations that are not covered here as they generally do not apply much to nanocap-smallcap charts. Again, this resource is meant only to provide a jumping-off point. An even greater tool for beginning traders would be a large archive of knowledge such as Investopedia. It offers much more beyond the trading term definitions for which we’ve referenced it here.
Key Chart Indicators to watch:
- 50DMA (50-Day Moving Average): A breach of this point on a stock’s chart is generally considered a bullish indicator, also referred to as a breakout. Stocks currently trading above their 50DMA can sometimes have less resistance preventing upward momentum.
- 200DMA (200-Day Moving Average): Passing the 200DMA is a definite confirmation that the stock has been on a bullish run, however, it is at this point that stock can often get top-heavy, and lose momentum. This often leads to a pullback, which can provide ample bounce-play opportunities (more on that in a minute), if the bottom is properly timed for entry.
- MACD (Moving Average Converge Divergence), Slow STO (Stochastic), & PPO (Percentage Price Oscillator): While they represent formulae with varied factors, these three indicators are generally read in a similar fashion. They are plotted with lines representing the relationship between different exponential moving averages over time. When lines converge and turn upward, it signals a possible forthcoming bullish trend. These indicators are usually accompanied by a histogram (often shown as blue bars) that gauges their apparent strength.
- RSI (Relative Strength Index): This useful indicator displays a comparison of the severity of recent gains to recent losses as a single number between 0 and 100, which is used to denote apparent strength. The resulting line is plotted on the chart, and can give you a good idea as to whether the stock is overbought, oversold, or somewhere in between.
As mentioned previously, following a big spike in price, it is common to see a pullback, or consolidation . Once a chart reaches its bottom, often at a previous support level, we begin looking out for a bounce. These bounce-plays, as we call them, can often lead to gains amounting to a significant percentage of those made by the surge that preceded them.
Higher Highs, and Higher Lows:
We constantly look for stocks that continuously raise the bar on both their lows and highs, as this is very often a bullish confirmation. When coupled with a breach of the 50DMA, this phenomena can give us a very good clue that an uptrend will continue.
These various chart patterns are not a guarantee when it comes to predicting the movements of a stock (like we said before, there’s no real way to do so), but with proper due diligence, and understanding of market mentalities, a healthy working knowledge of common setups and indicators can really give you a leg up.
This concludes Lesson One of Penny Stock Trading School! We hope you found this article to be informative and straightforward. Check back for future updates with more information on how you can take some of the mystery out of the wonderful world of penny stocks. Happy Trading to all, and good luck out there!
Basic Order Types
In our latest Trading School lesson for beginning stock traders, we will explain the two primary order types, Market and Limit, as well as the different parameters that can then be applied through the use of various other order instructions.
A Market Order is the most basic order type, containing no entry requirements other than the current market price. Market Orders can also be thought of as “open-ended”, in that they contain no instructions for the sale of the stock.
Basically, when you place a Market Order with your broker, it is the equivalent to saying “Fill my order as quickly as possible, at the best possible price.”
As a result of these loose guidelines, Market Orders are almost always filled, provided the stock is liquid.
Limit Orders are just what they sound like: Orders that are only executed at a specific price, a limit set by you.
Using limit orders, you are afforded a measure of control to avoid paying more than you want for a given stock. Like Market Orders, basic Limit Orders only contain instructions for purchasing a stock, not selling.
Fair Warning- Some brokerage houses charge higher commission fees for placing Limit Orders, essentially because it curbs their ability to build profits for themselves into the price at which they would fill a Market Order.
All or None (AON)
This instruction simply demands that you are filled with the entire amount of shares requested, or none at all. Be aware that without this parameter activated, any orders you place are subject to partial fills.
Now, we’ll look at some of the order parameters that include instruction for the automated sale of a stock.
A Stop-Loss protects the purchaser from damaging losses by allowing one to set a price target lower than the current market value that would trigger a sale, should the stock fall to that level.
Some might argue that one should always use Stop Orders as a precautionary measure against unacceptable losses.
A Trailing Stop Order serves the same purpose as a regular Stop Order, but instead of a specific price acting as the sell-trigger, it is a set percentage of the market price.
This is for instances where a stock continually rises. Instead of having to adjust your Stop every time the stock trends up, the Trailing Stop will “follow” the price up, and remain set to trigger a sale should the price fall a specific percentage below the market price.
Every purchase order contains a designation pertaining to how long it should remain open. The basic designations are as follows:
Good Till Canceled (GTC)
While some brokerage houses may have limits on how long they will hold an order open, essentially a GTC Order is meant to be held until it is either filled, or canceled by the purchaser.
A Day Order, unlike a GTC, only remains open for the remainder of the trading day on which it was placed. If you have not been filled by the end of the day, the order is automatically cancelled.
LESSON 3: INTRO TO DUE DILIGENCE
Always do your own due diligence!It is a phrase that everyone within the investment community has heard, and understands to be wise. But what about “green” investors, people of all ages who are new to stock trading? The task of understanding Due Diligence in the context of stock trading and how it’s done can be daunting, and seem overly complex. Fortunately, we’re here to tell you that it does not have to be so. Forming a basic comprehension of how to gauge the value of a potential investment, is actually a quite straightforward process. In this Trading School Series, we are going to start along the path to understanding how to conduct Due Diligence.
In essence, when someone tells you to “do your due diligence”, what they are really saying is: “When it comes to evaluating a stock, don’t take someone else’s word for it. Take it upon yourself to build a more detailed picture of that company based on a number of factors, to aid you in your risk/reward assessment.”
The first, and most basic thing that one generally notices, is the Market Capitalization of company, or “Market Cap“. A Market Cap is essentially the number of Outstanding Shares multiplied by the current market value of a single share. See the preceding image which defines the different market capitalization designations.
A higher market cap, carries with it both lower risks and potential rewards. A microcap stock is likely to be very volatile and highly risky, yet can return rapid gains at a moment’s notice. It is important to determine the level of risk which is acceptable to you as you pursue your investment goals, and understand that it changes from stock to stock. (Our regular readers know that personally, we seek out high reward potential, which usually lands us in the high risk realm of microcap trading.)
You’ll also need to gain a basic understanding of the different kinds of filings made by a company that disclose vital information. Here are a few of the more significant types:
A 10-K is a yearly report which contains much of the information you’re going to need to accurately determine a company’s strength. It contains the balance sheet, which denotes assets, liabilities, and net worth. 10-Q‘s contain quarterly financial statements of the same information over a shorter timeframe.
A company will file an 8-K to announce unscheduled current events such as acquisitions, material definitive agreements, changes in management or the direction of the business, future plans, etc.
Form 4‘s indicate insider buying or selling. Company officers are required to report the size of their positions as well as the purchase price. A large purchase by management at a higher price than market value, hints at confidence on the part of those individuals, which certainly know things about the company that are unknown to the public. While one shouldn’t take these transactions as definitive proof of anything, it is just one more factor that can be added into the overall picture, as one attempts to familiarize oneself with a business.
While facts and figures are certainly very important, Due Diligence isn’t 100% about the numbers. It can sometimes be easier to gain a better feel for a certain stock by improving your frame of reference; it never hurts to check out the competition. Companies that operate in the same industry sector as that of your target stock can provide a more comprehensive picture of its past, present and potential future. And who knows, you may end up unearthing an even better opportunity in one of the competitors.
Looking at the history of the stock is important as well, both on the news wires and the chart. While it’s true that ‘past performance doesn’t guarantee future results’, patterns do emerge on the chart which occur with somewhat predictable regularity. See our previous article about basic chart comprehension for more on the subject.
Understanding the basic terms and principles in the preceding article is your first step to conducting effective due diligence. Stay tuned for the next Trading School: Due Diligence installment, where we’ll be talking in more detail about Balance Sheets, and Cash Flow Statements.