Penny stocks are companies that trade at a share price of less than $5. Their share price gives you an indication of the struggle that the company may be going through. At some level, there are some that question the long term survivability of the company. Others face stiff market competition from entrenched and well known companies. Some penny stocks are involved in emerging technologies that have yet to gain widespread acceptance and others face the question of whether their cash will run out before they are able to turn a profit. Simply put, penny stocks are companies struggling for one reason or another. That is why they do not make the best long term investments. However, trading penny stocks is another story.
You can choose to invest in penny stocks and hope that that you get lucky at some point by choosing a winner that will produce ten or twenty times your money. However, the majority of companies that you select may not make you anything long term. There is a distinct possibility that they will cost you money. The better choice would be to trade penny stocks and look to buy shares of companies that may present a better short term trade opportunity than others. One of the ways to determine what is a short term trading opportunity is to use technical analysis. By using technical analysis you are allowing price action of the stock to determine your trading decisions. You will go long when the trend appears to be heading up and you will short penny stocks or sell your position when the trend is reversing.
Before looking at a few trading pattern that you can use to increase your trading profits let's look at why people are drawn to penny stock trading. Micro-cap stocks have a tendency to make larger percentage moves than the average stock. Larger percentage moves allow for greater profits. Low priced stocks are volatile and volatility is what the average trader is looking for. Traders like to move in and out of positions as quickly as they can. They do not want to allow their money to sit around in a stock that is merely trading in a sideways range. If you were an option trader you would pay extra for volatility, however, penny stocks give you the best of both worlds. They provide volatility at a low price.
One more thing before we look at some trading patterns. Make sure that you are trading penny stocks with adequate liquidity. You do not want to trade companies that have be easily moved or manipulated because they trade so few shares. I would only consider companies that trade in excess of 300,000 shares each day. I prefer companies that trade at least 1,000,000 shares on average but will settle for those that about one third that amount. You need to make your own decision on this but be careful, especially if you choose to trade penny stocks with fewer than 100,000 shares of average daily volume.
So what are some technical analysis methods that can be used to effectively trade penny stocks. Let's take a look at a few of them.
Trade Range Bound Penny Stocks
If you look at penny stock charts you will notice that that appears to be what we would call channels on a chart. A stock is said to be trading in a sideways channel when it has a defined resistance level and support level. In most cases, you can draw a line across the lows of where the stock is trading at the bottom of the range and you can draw a line across the highs when the stock is near the top of the range. This will show you the support and resistance levels. The stock will have a tendency to stay within that range unless some news causes it to break this range in one direction or another. If you were to trade a range bound stock you would buy when the share price was near the lower end of the trend and sell when it reach the top end of the trend. However, you will need to be aware if the stock breaks out of the trend. In this instance, you will need to close you position and consider trading the next type of method.
Trade Penny Stock Breakouts
When penny stocks break out of a trading range (no matter what direction) they will have a tendency to continue in that direction. This is especially true if the if the breakout occurred on higher than average volume. You will buy penny stocks when they break above a trading range and short penny stocks when they break below the trading range. You can be quite profitable just looking for these types of scenarios. I would recommend following a group of companies and look at their charts everyday so that you can see these trends forming and so that you will know what share price you may want to enter a trade on a breakout.
Trade Penny Stocks Using Divergences
Many traders will use divergences between price and a particular indicator like MACD. If the price is moving down but the MACD value is moving closer to the zero line that it was in the past then it might be an indication that a trend is ready to reverse. Recently, I have been looking at the divergence between two different short term indicators. I have been looking at a divergence between the 2 day RSI and the 2 day %R Williams indicator. Most of the times these two indicators move in tandem. However, there are times when the % R indicator will trend up from one day to the next but the RSI reading will continue lower. Often this is indicative of an upward move about to come. Nothing provides a trading certainty but this has been pretty good. As always know where you will stop out and stick to your trading plan.
These are just three ways that you can use technical analysis to effective trade penny stocks.