Penny stock markets are the eldorado for stock pickers. Enjoying a penny stock pick that explodes tenfold is like finding gold in the desert. There we are. Beyond the gold that it carried Eldorado was indeed a desert. Small stock markets are similar. Most of these stocks traded there are illiquid, forgotten or completely unknown.
But every now and then trading activity concentrates on a stock that previously was on no one’s radar. Suddenly the trading volume spikes and the price rises like Phoenix from the ashes like here with Clean Diesel Tech. The stock ran up sixty-fold in less than two weeks.
Stock picking in the penny stock markets is different to choosing a large cap stock. You literally have to scan the market and look for highflyers of the past that sank into the dust of the penny stock desert.
It is this statistical undervaluation that is the real chance. Penny stocks don’t offer much fundamental information and they have often a fickle chart. If a market is illiquid, prices are moving not at all or they are drifting slowly away without any meaning. It is difficult to read such a chart.
TA in the small cap markets is useless. At least for most stocks that currently have no trading volume. If a stock finally catches fire and the traders come back, then we have a working market that can be traded by chart reading. But before that point the entry has to be determined differently.
This is a severe obstacle, but only for the chartist or the TA expert. For the value investor or speculator, aka the gold prospector, it is a gift. Where no TA is working, TA has not to be applied. You don’t have to worry about wrong timing. When there is no need to trade a stock pick, trading becomes easy.
Does the penny stock prospector need no timing at all? Buying undervalued small cap stocks needs timing. Every investor wants his investment to go up as soon as he is in the position. Timing is always useful, no matter how value investors like to deny this.
Timing a penny stock entry is simple. First, you have to concentrate on this Phoenix-from-the-ashes type stock. Once it flew high and made proudly volatile swings at an impressive altitude. Then it crashed. Now it is forgotten. But recently it has shown signs of new life. Volume and price expanded. Something is happening there.
That is the trading signal for the penny stock speculator!
It doesn’t matter what exactly the reason is for this unexpected activity. Yes, it would help to know about the driving force. But in most cases you simply can’t, at least not for sure. And that’s where the statistical idea comes in. Trading and investing is statistics anyway. Why not accept this and completely rely on statistics?
If you choose carefully a stock that is in the SP500, gather all available fundamental information, and study the opinion of all analysts that follow the stock, what is your chance to make a profit with this stock?
Right, it is about 50:50, like flipping a coin. It could be a bit higher like sixty percent probability for a gain. But it could also be lower than fifty percent and still be the basis of a profitable trading system. In that case the average gain has to be bigger than the average loss.
Important is one thing here. There are no sure-fire bets like eighty percent or so. Such monster trades only exists in the advertising and with Forex robots.
A Forex robot has a hit rate of eighty percent or above? Yes, but it also has a dirty secret. It makes many small gains but incurs few hefty losses.
The simple way to achieve this profit pattern is to wait until there is a gain and sell into it. Often the trade is almost immediately profitable, more often the robot has to wait a little longer. Sometimes the drawdown is severe but the price finally comes back and our robot smiles.
But then it comes. The inevitable bad day where the price tumbles through the margin line and the robot blows the account away. Now it grins…
Whether it is a Forex robot, the hyper trading system, or the thoroughly planned investment, they all have one thing in common. The outcome is unforeseeable. A gain gets statistically compensated by a loss.
In the penny stock markets things are no different. Investing in penny stocks may mean that you get trapped in an artificially promoted stock. But so what? If it was cheap in the first place compared to its highs of the past, it has the potential to climb further after your buy. Even if the reason for the rise is nothing but a con.
Of course, it could be also something else like recovering business prospects or some abrupt game changing event. We can’t know it for sure, only later we will know. At that point everyone pretends that things were clear from the beginning on. As usual. The human mind likes to delude itself.
But reality is different. In the stock market one thing is not known and that is the future. Otherwise we would be all millionaires and that is impossible. You can also see this from a different angle. If a price were predictably higher in the future, the market would react instantaneously and adjust the current price to that level. The result would be again only a 50:50 trading possibility.
There are no sure bets. It is all speculation and the penny stock picker does best by simply accepting this truth and adopting a trading strategy that embraces the statistical outcome of a trade.
Here is the statistical penny stock trading strategy:
Monitor stocks that are cheap compared to their historical highs.
Scan this subset for exploding trading volume and price.
Analyse the fundamental and product situation as well as possible.
Hold until the excitement is over. Volume dries off and the price retreats.
Either sell without any specific signal by a trailing stop of, say, 50 percent,
or exchange the stock with another more promising candidate.
The first three items can be supported by our recommended small cap stock picking expert (me) who has dug out many x-baggers in Eldorado over the years. I am neither a genius, nor a prophet, but I am aware of the principle of statistical undervaluation. Together with the asymmetry of possible gain and maximal loss this is enough to conquer Eldorado. Have a different strategy and you may find yourself digging over a desert!