Technical analysis is the trading method with the fasted possible return, simply because you can bet on the highest volatility. To put this to an extreme, apply TA to penny stocks. Penny stocks stand for volatility pure. Could this be the ultimate mix for high velocity traders? Yes, but… these penny stocks have a dirty secret. No, I don’t mean here that this market has probably the highest fraud quotient. It is something else.
Penny stocks have their own technical analysis rules. Price movements in the low cap markets work different. Price behavior is driven by supply and demand in the penny world. Isn’t that true for all trading? Of course, but for instance with larger stocks, supply and demand is much more coupled to price. That means that strong hands generally buy only below some certain price and sell above another limit. Investors gauge the value of stocks.
In the penny markets things are different. Calculating the value of a penny stock company is in most cases impossible. Either there is not enough fundamental data available or the company’s earnings or even revenues are not existent. In other words, there is only virtual value and that is hard to understand. From the viewpoint of game theory the best estimate for the value of a company behind a penny stock is the historic price range that its stock experienced in the past.
All this means that demand and supply in the penny markets are mostly not correlated to the relation of perceived company value and stock price. Instead, demand explodes at times, for various reasons. One of them, to mention it again, is of course pump and dump. But there are also more legitimate reasons why some traders suddenly pay almost every price to get into a stock. The outcome is an exploding price.
Here we have it. The technical analysis for penny markets boils down to two simple rules:
Look for a volatile stock being in the lower half of its historic range, on a logarithmic scale of course. Such a stock offers value, statistically.
Enter the market when a first sign of renewed activity in the stock shows up. Price and volume are surging.
The first system rule sounds like a slap into the face of an investor who is accustomed to investigate and analyze a company’s fundamental data and product situation. But believe me, even with larger stocks so and so many misinterpretations happen all day long. Look at a chart. The price is fluctuating wildly! Not a good sign for believers in perfect valuation. The smaller the stock the worse the situation becomes.
The second rule of this penny stock trading method sounds primitive and it is probably the next slap. This time sophisticated TA believers are the victims. But because in the small cap arena trading activity appears chunk-wise, it is enough to make the entry. All more elaborated TA methods fail more or less. Even trend trading is difficult, because trends in the penny stock markets tend to be more aggregated explosions.
Finally, you just need, for instance, our source for fishing the few situations that are worth a bet in the world of small money. The small cap markets are huge and there is much price manipulation involved. You could need a relentless market scanner! Of course, you could also do it on your own, but given that penny trading is even more statistical than trading generally, why not give it a try – is it your ego?
Beach traders shouldn’t have an ego, they have the sun…