Entry Strategy #2
New Items
Now I do not trade news items like you probably think I trade news items. I do not trade specific news items for an individual company. The only news items that I trade are spectacular news items. I know that is a little vague so let me explain.
During this past year we have had an issue with Swine Flu. When the news on swine flu first came out there were a few companies who got an immediate hefty bump in their stock price. They were companies that work on creating vaccines. Traders just gravitate toward stocks that may offer a solution during a current crisis. It doesn’t even mean that a particular company will necessarily get a contract; it is mere speculation. It provides a trading opportunity. In most cases, since there is no real reason for the run up in the company, this only last a couple of days. So you will need to take profit quickly, within the first 48 hours most likely.
There are companies that spike with news of a big hurricane season. There are companies that run when there are oil fires to put out. There are companies that move up when airport security becomes an issue. Whatever issue you can name there is usually a company that has a product to meet a need.
Below are a few examples of what I am referring to.
Novavax is a vaccine company. When the talk of swine flu came out, it spiked. You need to be all over this on the first day that it begins to move because you most likely will need to sell the next morning. You could have purchased NVAX at .80 to .85 cents when the news first came out. The next day you could have sold at $3.50 on the open. That is a 300% move in just one day. So pay close attention to the news that might affect some stocks.
The chart above is of Boots and Coots Inc. The company was named after the nicknames of its two founders. They have diversified over the recent years but were primarily a company that fought fires in oil wells. On March 20, 2003, the US invaded Iraq. Oil wells and pipelines were sabotaged during the war. Who you gonna call? Boots and Coots. You can tell there was a slight run up in price prior to the invasion in anticipation of what might happen. Notice the explosion? The interesting thing is that it came before the actual invasion. It was quite obvious from the watching the news at the time that we were going in. If you waited for the actual invasion you would have lost out. If you had anticipated you would have experienced great profit.
On February 21st you could have bought for $1.20. On March 19th (day before invasion), the stock open at $9.52. That represents nearly 8 times your money in about a month. You need to look for these opportunities.
Entry Strategy #3
Support/Resistance Lines
Support/Resistance lines are often great places to initiate a trade. I should probably term this strategy support/resistance levels since I use both trendlines and moving averages. Let me define support and resistance levels for you. A support level is merely a spot on the chart where there seems to be a lot of buying. This is most likely because many people feel comfortable with the stock at that particular trading price. When there are many who perceive a stock to be a good value at a particular price it will most likely not slip too much below this level. It will take some sort of negative news to move the stock below this level. Of course if that negative news does come you will want to get out of the trade. Take your loss and move on.
A resistance level is just the opposite of support. It is that spot on the chart where there seems to ba a good amount of selling pressure. This spot can be used to initiate a short position if you are so inclined. As I have described earlier I am not often inclined to do so. I use resistance lines a little differently. I look for stocks that are able to break through levels of resistance. Something has propelled the stock past a sticking point. When this happens it is usually good for a little run (which is all that I am looking for).
That gives you an idea of the broad concept of support/resistance lines, so let’s take a look at what this looks like in real trading.
Below is a recent chart from Agfeed. As you can see there appears to be a support level around $4.30. Each time it slips to this point it has a tendency to rally. This would be a decent place to enter a position if you were going to trade this stock. In the last 6 months the stock has bounced off of this level 5 times. Two of the times it could have provided at least a 20% return.
The next chart below is an example of a penny stock that finally breaks through its resistance. ARIA had a resistance level around $2.60. Finally it broke through on good volume on March 1, 2010. To date it has run around 40% from its breakout. This is the power of a stock that shatters through resistance. It appears that Newton’s first law of motion even applies to penny stock trading. A body in motion tends to stay in motion. When the stock breaks through resistance it is in motion and it will tend to stay in motion for awhile. This will provide you with a trading opportunity.
Tags: penny stock, penny stock entry strategy, penny stock trading, support/resistance lines
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Price Move Through Exponential Moving Average
This is by far one of the simplest and most effective trading strategies when traded correctly. It will give false signals but it will also get you in for some major runs in the stock. I have a few other things that I look for in conjunction with this. I will touch on them in a second but first let me tell you what moving average I like to trade. I do not enter trades on the basis of 200 day moving average. If I was a long term investor I might use this but as a trader the time period is way too long.
My personal preference is to use a 21 day exponential moving average. However, sometimes I will adjust this depending on what has provided the best returns on a particular stock in the past. A great feature of IncredibleCharts.com is that it allows me to move back into the past and then to step through one day at a time to see how the stock trades. I can see, first hand, what moving average works best for which stock. It is also cool because it allows me to apply my entry and exit parameters to see how I would have fared.
The other factors that I look for along with the move through the moving average are as follows:
- Good volume on the day that it broke through the 21 EMA
- The stock in a recent downtrend
- A sloping/curving pattern at the bottom of the downtrend
The above factors make, for me, the most explosive moves for this entry strategy. Let me expand on a couple of the points. It is ideal when there is an elevated volume on the day the price crosses the moving average. If there is below average volume I would probably exclude the stock from trading consideration unless the volume picked up in the coming days.
If the stock spiked through the moving average, I would wait till I got a pullback closer to the moving average. I am reluctant to buy penny stocks after big one day spikes. It is often the high mark for the short term.
I, also, would prefer to see the stock open above the moving average and stay above it for the trading day. This is not essential, although, it gives me better comfort with the trade.
I also want to see the stock in a recent downtrend. Again, this is personal preference. If the stock is in a sideways trend then I am not interested. It will often cross through the moving average if it is in a sideways trend. This will create many different false signals. That is why I look for penny stocks coming off of a recent downtrend. These entry signals are more reliable.
The last thing that I want to see is sort of a sloping downward curve. I want to see this curve right before it breaks through the moving average. If the stock has made a sharp upward move to get to the moving average then I am not interested. It doesn’t mean that you can’t make money with such a trade, I just believe that there is a better chance of success if it hasn’t made a major run.
Let’s take a look at some real world example of how this would appear on a chart.
On each chart you will notice a purple line. This represents the 21 day EMA. In the chart above of A H Belo Corporation you will notice that it has broken through the moving average twice during the time frame shown. Notice that each time there is a sloping downward and then the stock breaks up through the moving average. Each one of these would be a tradable move. As you can see this simple strategy can be quite profitable if done correctly.
In the first instance the stock broke through the 21 EMA around 1.04. It traded at the EMA or a penny or so lower for a couple of days and then it began to move higher. After a three day run the stock pulls back and now used the 21 day EMA as a support. It then began a second move and traded as high as $2.24.
If you would have bought the morning after it broke through you would have bought for $1.10. I will cover the exit strategy later but for right now I would have stopped out when it moved below the open of two days before. This would have gotten you out of the stock at $1.50. It had moved as high as $1.75 but I gave up that profit for the possibility that it might move higher. You can never pick the bottom of top of a run. The move from $1.10 to $1.50 represents more than a 35% move in only 8 days. Not bad.
I would have purchased again as it neared or touched the moving average. After it has broken through the moving average it serves as sort of a support level. The very same day that I stopped out at $1.50 I would have purchased for $1.20 later in the day. Although I could have gotten out at a much higher price I would have stopped out around $1.85 about 9 days later. That represents another 50% move.
I probably would have purchased when it touched the EMA again and would have lost a small amount of money on the trade (probably around 5% or so).
Once again the stock breaks above the EMA on July 20. I would have purchased at $1.10 the following morning when it opened. I would have exited around $3.00 14 days later. I most likely would not have re-entered this trade unless I did so on the gap up a couple of days later. This amounts to a return of about 172% on this trade alone. It you have invested $10,000 into the original trade and rolled all profits into each subsequent trade you would have turned it into $54,000. And this includes the 5% loss. This is the power of penny stocks. Let’s look at another example.
Lee Enterprises also breaks through the moving average a few time in the chart above. To be fair I would not have traded the first break of the 21 EMA since the stock was trading in a sideways pattern. However, you will notice that the stock did spike quite heartily. I could have entered the stock on the basis of another strategy that will be discussed later. The stock tripled in a six very short days.
I would have entered the stock the day after it crossed the moving average on July 16th at 67 cents. You could have gotten out over $1.90, however, I would have waited and been stopped out at around $1.40. That would have been a little over a 100% return. Maybe you will be able to do better than me. Maybe you will be satisfied anytime you get near a 200% return. I guess I am just stubborn. I stay in on the off chance that the stock decides to take off and not look back.
US Airways shows yet another example of a gently sloping downward curve and then a break of the EMA to the upside. This kind of example can be found quite often. IncredibleCharts.com has a scanning feature that will allow you to find these quite easily.
Tags: entry strategy, exponential moving average, false signals, penny stocks, trading strategies
Develop Firm Entry and Exit Parameters Before Making a Trade
Rather than give you particular entry and exit parameters you need to define these yourself. Every person is different. What is right for me may be uncomfortable with you or vice versa. But please understand you need to DETERMINE YOUR ENTRY AND EXIT PARAMETERS BEFORE MAKING YOUR FIRST TRADE. What do I mean by this? Let me explain.
Although I believe in time intuition can play a part in trading I do not want your trading to become a series of hunches. I want you to have specific reasons for getting into a stock and for getting out of a stock. A trading system will bring success; trading by the “seat of your pants” (as my grandparents used to say) will bring you heartache.
I will give you a variety of entry signals in the coming chapters. You can use them or adopt your own. The first question you will need to ask yourself is why am I getting into this stock? What will prompt you to enter a trade. I would recommend that you have 4 or 5 entry parameters that you work with. A few stocks on your trading list may give you signals at the same time. If you need to use intuition here is the spot to do so. Use your intuition to narrow down the candidates to one or two stocks that you will enter.
The second question that you will need to ask is what is giving to cause you to get out of the trade. You need to know this going into the trade and you need to stick to it. I cannot emphasize how important it is not to exit a trade too early. There will be a temptation to take you profit and run. Do not do this. Allow your exit parameter to make that decision for you. Sometimes you will turn a 10% gain into a 10% loss but more importantly sometimes you will turn a 10% gain into a 40%, 50% or even 100% gain.
It is these large gains that will ultimately propel your trading profits. If you exit at the first sight of profit you will never be successful. Remember that one of the keys to trading in to let your gains run and cut your losses. Do not cut your profit short. The only way to do this effectively is to know ahead of time what will get you to close the trade. Don’t try to decide mid trade; your emotions will get the better of you.
I will give you specific exit parameters in later chapters. You can use them or you can develop some of your own. But please use something.
Tags: entry parameters, entry signals, penny stock, penny stock trading, stock, stocks, trading rules
Beware Regulation T
I wanted to throw this in before I got to the last trading rule. For action trader, Regulation T can be a thorn in the side. The basic gist of Regulation T is that you need to have the cash in your account in order to trade. Seems like a simple concept but you need to be careful. If you trade in a cash account (no margin) or you made a habit of being fully margined, Regulation T can be an issue.
Let me explain. Let’s say that on Monday morning I have only $5,000 of buying power left. The rest of the account is already committed to other trades. An entry signal is indicated in stock ABC. ABC is trading at $2.40. A quick calculation tells me that I can purchase 2000 shares. So I do. It turns out that my timing couldn’t have been better ABC closes on Monday at $2.64. On Tuesday morning, ABC gaps up to $3.10. I have a one day gain of 30% and I am satisfied so I sell the stock. I am now credited with a little more than $6000 buying power in my account. But there is a catch.
Stocks take three days to settle. This means there is really not any cash in my account as of yet. Since I sold on Tuesday, it won’t show up till Friday. However, the brokerage houses allow you to use the future money to purchase other stock with one caveat. You would not be able to sell it until Monday at the earliest. The previous sell must settle before you can sell again.
So if later on Tuesday XYZ indicated an entry position and I purchase 1000 at $4.50 I am obligated to stay in that stock until Monday. If I sold it prior to that then I would get a nasty letter in the mail saying that I committed a Regulation T violation. The letter will most likely say that if I do it again my account will be restricted to cash only transactions. In other words, I will only have buying power equal to the settled cash in my account.
Normally, this is not a problem. However, if XYZ quickly turned against me then it could become an issue. I just wanted you to be aware of the rule since you will most likely be an active trader and you could run up against this. And if your are wandering, yes, I have been the recipient of a Regulation T letter.
Tags: brokerage houses, entry signal, penny stock, penny stock trading, Regulation T, stock, trading rule
Prepare a Trading List or Develop Trading Scans
One of the big factors that lead to failure in trading is the lack of trading ideas. In the absence of trading ideas the average trader will gravitate to ideas they hear from others (TV, friends, etc.); they will subscribe to some ridiculous pump and dump penny stock recommendation sheet/newsletter or they will be swayed by news items or they will fall into the trap of some other non specified lure into a stock.
I want you to generate you own trading ideas. You do not need to be dependent on anyone else. There are free tools available that will allow you to do anything and everything you need. I do not use any paid services. I primarily use three services which I will talk about later in the tools chapter of this book. However, I will list them now for you. I use Incredible Chart for most of my charting. Since Incredible Charts doesn not provide intraday data, I use StockCharts.com to see how a stock is acting intraday. I also use Microsoft Money’s Deluxe Screener. Do not kid yourself into thinking you need anything else.
You need to generate a list of 20 – 30 companies who meet the volume and price criteria that we have talked about and look at them every day. This list will provide you with most of the trading ideas that you will need. I also recommend that you put together a few scans that also provide trading ideas. I have some scans that I have created that I use with great success that I will tell you about in a later chapter.
You cannot successfully follow 100, 200 or more companies. Once again focus and concentration is the key. Learn the 20 – 30 companies on your list. Learn their business, learn how the trade; learn any seasonality patterns or interest rate patterns. Learn their support and resistance levels. Know them inside and out. If you do, you will find success.
Understand you can generate all the trading ideas you will ever need. Please stay away from all of the penny stock tip sheets, recommendations and the like.
Tags: incredible chart, penny stock, penny stock trading, resistance levels, stock recommendation, stock tip, trading rules
Trade a Limited Number of Positions
I am going to make a bold and controversial statement. Here goes. Diversification is overrated. Diversification will cost you profits. I am not a fan of diversification as you can plainly see. Let me explain why?
You are not a mutual fund manager. You are not managing millions or billions of dollars. If you were, diversification would be important. They simply cannot pour that much money into just a few stocks. They would move the market. You, however, will not do that. The average individual investor is usually not putting $500,000 and up into a trade.
Diversification makes it too difficult to keep track of everything you are trading. Though his method is much different than what is described here, the greatest investor of all time (Warren Buffet) is not highly diversified considering the amount of money that he has invested. Neither should you be. You will be more effective as a trader when you are focused.
Let me give you an example. Let’s say you invested your entire account every time you made a trade. I am not advising this as you will see in a moment but for the sake of the example let’s make that assumption. Let’s also assume that you were starting with $25,000. During an unspecified time period you made trades that resulted in the following percentage losses or gains (reading down):
-15% +20% +15% +25%
-10% +40% +20% +20%
+30% -15% -10% +10%
+10% -10% -10% -15%
-10% +35% -15% +20%
In our example you made 20 trades, only 11 of which were profitable. In fact, you started your trading career off with two losses. In the above scenario are not found any 100% or 200% returns which penny stocks can do frequently. Here is a question for you. Would you take the above scenario or would you take an overall guaranteed 25% return? A 25% return during this same time frame would have increased your $25,000 to $31,250. What about the above scenario? You would have a little more than $68,000. This is what happens when you take small losses and big gains. Unfortunately, the average trader takes equal size gains and losses or they get it completely backward and take small gains while suffering big losses.
But maybe you are thinking to yourself this is too rosy a scenario. How would you have fared if you had suffered a 50% drop in value due to the stock collapsing overnight? Let me say that this will rarely happen since, as you will see later that we will be trading companies who are beginning a new change in direction or are continuing a well established trend. But I do acknowledge such a possibility could exist although it has not happened to me. Let’s assume that the one that the one 10% loss (bolded and underlined) actually was a 50% loss. How would you have fared? You still would have nearly $38,000, which is more than 21% better than trading a well diversified portfolio.
The point is that there is power in concentration and weakness in diversification. Diversification acts as some sort of dilution. I will grant ou that diversification is less volatile and as a result by its very definition is safer. However, it is not as powerful. Once again the key is discipline. If you can be disciplined you can make it work for you. Big rewards are ultimately the product of bigger risks. Playing it safe will not grow you money exponentially. The day I realized this was the day my account began to grow.
So how many positions is too large. For an average size account I would not hold more than five. Even if you were sitting on $1,000,000 I would not have more than ten at any one time and would often not carry more than five.
Tags: diversification, penny stock trading, penny stocks, trading rules
Do Not Double Down
One of the most common practices that I personally believe gets them in the greatest amount of trouble is doubling down. What is doubling down? In essence, it is adding ot a position that has turned against you. I am convinced that this is the surest and quickest way to lose money.
Let me give you an example of “doubling down.” We are going to assume that penny stock ABC has given you an entry signal to buy. You did not jump the gun on the trade; you got an honest to goodness buy indicator. So you buy 1000 shares at $3.50. You are primed and ready to make money. However, four trading days after you purchase ABC they issue a somewhat unfavorable press release. The stock opens up at $3.43 and drifts throughout the day.
You had told yourself that you would sell the stock if it fell 10%. So if it hits $3.25 you should be out of the stock. But for some odd reason it finishes the day at $3.10 and the stock is still in your account. Why? As the magical price of your stop was getting closer you began to reason that the news was not that bad and you think everyone is overreacting. You convinced yourself that the stock will recover, so you stay in the trade. The next day it opens at $3.06 and you add a second position. But apparently the market is not agreeing with your assessment of the stock because it continues to slide. Now you hope the privilege of losing money twice as fast as you did before.
I could continue on with the example and show you just how quickly you could lose a lot of money. When I first started trading again I did so with an account of about $18,000. I built it to over $20,000 in a short period of time and then n a matter of about 4 days I lost $5000 on one stock. I did not follow any rules and ended up owning 3000 shares. Finally, the pain got to great and I folded. It was a good thing I did. I don’t believe the stock is still in existence today. I would have lost even more if I had stayed in.
I forced myself to stop trading for about 2 months so that I could think through what I was doing. I couldn’t afford to make that kind of mistake again. It was during those two months that I formed the rule I am speaking about. The interesting thing is that just the other day I came across an article where someone recommended doubling down as a way of enhancing profits. I couldn’t disagree more when it concerns the world of penny stocks.
Let’s think about this logically for a moment. Why would you invest more money in a stock that has given you a sell signal? In case no one has ever told you: the trend is your friend. I should rephrase that. The trend is you friend if you are trading in the same direction. It is your enemy if you are doing the opposite.
Please understand that you will enter trades that are dead wrong. That is OK. It is not the end of the world. However, it can quickly become the end of the world if you add to it. Adding to a bad trade only gives you the opportunity to lose money at an accelerated pace. On top of it you are removing capital that could be better put to use in another trade. You lose the opportunity to make money.
When you take a position in a stock you will only do on thing in the future: sell. You will not add to it. You will not sell a partial position. The only thing you will be allowed to do is sell the entire position. If you made money, rejoice. If you didn’t make money, then shrug it off and see if there are any lessons to learn.
Tags: double down, entry signal, penny stock, penny stock trading, penny stock trading rule
Do Not Hold Penny Stocks into Their Earnings Report
This may sound like an odd rule but I believe it is important. Rarely is a penny stock going to produce such stellar results at their quarterly earnings report that the stock shoots to the moon. However, many of them will provide mediocre to disappointing results or guidance which can cause the stock to drop rather dramatically. Let’s remember what type of company we are dealing with. We are trading penny stocks. They are penny stocks for a reason. This means their company financials are not the strongest and their prospects for making money are not too great at the present time.
I would especially avoid earnings in our current economic environment. In a strong bull market you may be able to gamble a little more. I give you this warning because of personal experience. I have held many stocks into earnings and most of them I would have been better off selling. This also means that you will have to know when earnings are scheduled before purchasing the stock. If earnings are only 10 days away and your average holding time of a stock is closer to three weeks then you probably don’t want to take that trade. Some traders may try to convince themselves that they will just sell before earnings. However, if the trade hasn’t worked out as planned by the time earnings come around then there will be a temptation to stay in the trade. So I would recommend giving yourself at least three weeks before earnings.
Tags: holding time, making money, penny stock trading, penny stocks, quarterly earnings report