In the world of Micro Cap and Penny Stocks many technical indicators used in selecting large cap stocks is also used in the micro cap market. Finding bottoms reduces your downside risk. There are various strategies used to do this, we will explore a few of them in this section.
Why Do You Need a Trading Strategy?
Trading any stock, especially micro cap and penny stocks, can be a highly emotional experience. Anyone who has traded stocks before can relate to that feeling you get when you buy a stock and it goes down. It all has to do with emotions, this is the reason you need a system for trading, a system that takes emotions out of the equation.
People are attracted to penny stocks because they can invest a small amount of money and own a lot of shares, what really counts is your return. It is not uncommon to see returns upwards of 500%, of course a stock purchased at ten cents that goes to twenty cents doesn’t seem like much, but that is a 100% return.
To reduce emotional input, we have systems and strategies that fit your trading objectives. We will review some of the strategies that search for bottoms in these micro cap markets.
Exhausting Sellers
Computers, software, the Internet, all of these technologies have brought a plethora of information right into your living room. In fact, there is so much information it can actual make picking stocks more confusing. So, out of the millions of micro cap and penny stocks available to trade how do you pick the right one for you?
There are free stock screener programs, one of these can be found in the Yahoo stock quote platform. It’s not as extensive as other paid tools, but it is a place to start for free. A stock screener program allows you to set-up a variety of filters that will weed out stocks and narrow down the list of stocks that fit your criteria. For this strategy you will want to set-up two filters. One will search for fresh lows in a stock and the other will search for declining volume.
Bottoms in stocks come when sellers exhaust themselves; a rash of selling usually comes on some sort of negative news. People’s emotions take over and they start selling. You must analyze the news, if the news is so devastating that a company could go bankrupt, the bottom could be zero. If a company lost a few orders or had a setback due to some extraneous circumstances that it can recover from, then we could qualify this stock as a potential buy.
So, the key to finding a bottom using this strategy is dissecting the news to determine if the problem with the stock is permanent or is the event a non-recoverable situation.
Channeling
Channeling is a strategy that involves charting a stock’s bottoms and tops within in a certain range. Micro Cap and Penny Stocks have followers, these followers perpetuate the price movement in a stock. The cool thing about this strategy is finding the bottoms in stocks can be pretty easy and you don’t have to be a technically savvy stock picker to spot a good bottom.
It may be a bit more difficult finding filters to search out stocks that fit this pattern, so you might have to do a little more homework to find them. When looking at a stock chart you are simply looking for a pattern where the stock moves between two price points. For example: Within a six month chart stock ABC moved three times between fifty cents and one dollar.
This would be a return of around 300 percent in a 6-month time frame. One of the caveats you want to keep in mind is trading fees. Chances are you will be trading tens of thousands of shares when trading penny stocks, make sure you find a discount broker with low fees as not to eat away all your profits.
This is more a trading strategy for locating bottoms in micro caps, but a bottom is a bottom and making profits is what we are after.
Seasonality and Patience
You can find some excellent bottoms is penny stocks if you use a little bit of logic. Think about this, when would be the best time to buy a swimming pool if you lived on the east coast? In the winter, right? Prices are low and demand is low. The same applies to stock bottoms.
Now, this strategy requires patience and you should consider this more as a short-term investment based on cycles. Be prepared to ride the bottom on these stock picks for at least three months. If you are looking at a really low priced penny stock, and you are investing a few thousand dollars in it, then you may want to buy several blocks of shares over a month or so, this will all depend on the daily volume. Micro cap stocks do not attract institutional investors, when a stock is riding the bottom rail the daily volumes can dry up. You must pay attention to this if you are accumulating shares during this bottoming process, buying a large block of stock during this time can push the price up and cost you money too.
Bottoms and Trend Lines
When using stock charts you will find what is called “Trend Lines”. Another name for these indicators is “Moving Average,” there is a longer moving average which is commonly known as the 200 day moving average and there is the shorter version which is the 50 day moving average. What we want to look for is what is called a “Crossover Pattern”.
The 50 day moving average generally leads the 200 day trend line as it works its way to a bottom, when the 50 day moving average trend line breaks upward and crosses the 200 day trend line you have a potential change in direction for that stock. You will never hit the exact bottom price of a stock, but using just trend lines on a stock chart can really help you come close to bottoms and don’t forget, you can use filters on your stock screener to narrow the list of stocks that qualify for a crossover signal.
Things to Remember
Investing, trading stocks in general always involves risk, and this is especially true when it comes to micro cap and penny stocks. No one can always find the exact bottom of any stock, it’s impossible, but by using a proven strategy you can now consistently find prices in penny stocks where the downside risk is low and the upside potential is much greater.
There is a percentage of people trading these stocks based on emotion, some go by their gut feelings, in either case a proven strategy will win out over emotions or gut feelings in the long run. You must always know your exit price before you buy a stock. This is called “Putting a Mental Stop Loss” in place before buying a stock. So, when you buy a penny stock and you believe it’s at its bottom and it keeps going down, you will limit your losses by already knowing when to sell.
When trading micro cap and penny stocks use investment capital you can afford to lose, this is just in case the market goes haywire. If you choose a good strategy for finding bottoms in penny stocks you will not only make money over time, but you will enjoy doing it.
