The opinions expressed in this
write up are simply my opinions. I am not representing the firm I work for with
relation to this write up. I am doing this on my own free time as an investor
capacity. I have not been compensated for this write up and this write up
should not be relied on to make trading decisions. Please do your due diligence
to confirm my opinions as they are just my opinions. Any statements and
analysis herein are preliminary in nature and should not be relied upon until
your own further research and analysis is conducted. This write up does not
constitute tax advice or advice of any kind.
The purpose of this write up is to provide beginner
investors with lessons and tips I had to learn the hard way. I have been
trading for only five months and as such I still have a lot to learn.
The
Penny Stock Jungle
First and foremost, investing in penny stocks is
volatile. As such there is very high risk of loss with most penny stocks.
Because of this the potential for high reward is very attractive to certain
people willing to bear this risk.
Second, you will hear advice from experienced and
inexperienced investors alike to not “marry a stock.” In other words, do not
become too involved and emotional with a particular stock as most penny stocks
end up failing. Statistics show that between eight to nine out of ten new
business’ fail. Now layer in the complete scams and made up companies put on by
professional scam artists, that seem completely legitimate (or at least our
optimistic nature makes us believe), and you have yourself a market where
likely 999 out of 1,000 companies fail (this is a conservative estimate as I
could only find very few examples of stocks that were pennies once that made it
big)
Here is the link:
http://money.msn.com/inside-the-ticker/9-penny-stocks-that-didnt-stay-that-way
Third, success stories are very rare. We all know
Tym Sykes and frankly started trading in the hopes of being a Tym Sykes story.
However, we cannot all be a Tym Sykes story and most people trading pennies end
up losing money.
The following will be tips that I learned over my five months that may help you
avoid some losses.
1.
Practice before you start!
Most trading platforms (e.g. Charles Schwab,
E-trade) allow you to make free virtual trades. That is, practice trading
without using real money. This may allow you to become a more disciplined
trader and learn trading basics. This was one of the mistakes I made, which was
to jump in the deep end without knowing how to swim. I was fortunate to join
the market when the entire Marijuana sector was Bullish1 and
therefore made some pretty good gains before it turned into a bear market1. Had I not been in this situation, I likely
would have lost all of my initial investment.
In summary, make use of this trading feature. I spoken to some experienced
investors and some spent up to a year trading virtual funds before they began
trading with their real funds.
2.
Before you start trading with your real money set trading rules
Trading rules are exactly as they sound. Have rules
as to what percent gain you want out of each trade, what is the maximum loss
you are willing to take if your trade does not go as planned, don’t hold a
stock over the weekend, don’t hold a stock over night. Whatever rules you want
to set.
This seems simple; however, in practice it is very
difficult. Greed gets the better of us when a stock is rising and we hold
expecting the stock to keep rising. When a trade is going in the opposite
direction we expected, we typically hold in hopes that the stock will bounce
back. This is a bigger problem because when this cycle occurs, you may end up
holding on day one to just get to the price it started on day one. On day two
you may hold to get to where the price per share (PPS) started on day two. As
you can see, the PPS can keep sliding down and you end up holding each day in
the hopes of a reversal. Setting a maximum loss and keeping to it will save you
money in the end. It is not typical for a stock to reverse once it began its
trend downwards, at least not immediately, it could take days, weeks or even
months. Which means you may violate two trading rules: holding longer than you
set a rule for and losing more than allowed. There is a feature that allows for
Stop Losses which is a setting that allows you to set the lowest PPS that you
want that stock to reach. This feature, as far as I understand, is
controversial in the penny stock market because of its volatility. Meaning,
some traders may manipulate a stock to trigger stop losses. Overall I feel that
stop losses are good, but I think a mental stop loss may be better. I say this
because if you can abide by this, then when you see the PPS reach that level,
you can initiate a sell and the PPS may rise and you can avoid an unnecessary
loss. I have been the victim of some
stop losses that did not turn out in my favor. I set a stop loss and as soon as
the stop loss hit, the PPS recovered.
In my experience trading rules are very hard to
abide by. I need to do a better of keeping to my rules.
3.
Avoid buying on the market and setting limits
The first week I started trading, I did not know
that you could sell buy and sell limits on stock’s you want to purchase or
sell. Because penny stocks are so volatile, buying on the market1 can lead to purchasing a stock at a much
higher price than anticipated. For example, you see a stock that is hot and the
price per share (PPS) is .013 and rising and you want to buy. If you buy on the
market, the price per share can jump to .015 in a matter of seconds and you may
end up paying an extra .002 per each share. This can be compounded because
typically penny stocks are purchased in the thousands given their low PPS. If
you bought 20,000 shares, you could end up paying an extra $40. Similarly,
selling on the market will cause your shares to be matched up with buyers at
that specific point in time. Which means the PPS can drop substantially and you
could end up losing money when the PPS may recover.
The solution to this is setting buy and sell limits.
Make use of this option and you can sell or buy your shares at a desired PPS.
For example, say you acquired 20,000 shares at .013 and that hours later the
PPS had risen to .016. Typically, a disciplined trader will have established
specific buy limits when they believe the stock has reached a bottom for that
time frame. After they have their buy orders filled, meaning the PPS reached
the limit they wanted to buy at, they typically set sell limits for the amount
of gain they want from that trade. Let’s
continue with that .013 example, assuming that you have set a trading rule
(discussed above) of 30% gain per trade, could set your sell limit at .0169.
This way, when the PPS reaches this level all of your stock will be sold
(assuming there is demand at that PPS – Level 2 can assist with this, explained
in a later section) at that price and you have earned yourself a 30% gain on
that trade.
4. Level 2 –
A tool used by experienced traders that allows them to see the Bids and Asks1on a particular stock.
This tool is subscription based, meaning that you
will have to pay a provider. I currently do not have a subscription to Level
2 but plan on getting this as soon as I become liquid (meaning that I have cash
positions in my account rather than money tied up in stock). For now I use the free feature in Schwab that
allows me to see high level of how many bids and asks there are on a stock.
Bid vs. ask is not very intuitive. Every
stock, at every point and time, has a bid and ask. Meaning there are people
bidding (or willing to buy the stock at that specific level) and people asking
(or willing to sell their shares at that specific price)
(Picture is for visual learners only and does not
correspond to the example below, the above bids are stacked, meaning there is
support at the .012 mark versus a small amount of sellers at .014. However, the
last price was .013 and people are not wanting to buy until .012 and thus the
stock will likely drop)
(Picture is for visual learners only and does not
correspond to the example below, the above asks are stacked, meaning there are
more sellers than buyers, here a lot more people are wanting to sell at .031
versus people wanting to buy at .003, this will likely result in the PPS
dropping)
To make this more concrete let’s continue with the
example above. After you bought the stock you can see that there are 100,000
bids at .014 compared to only 100 asks at .014. This situation means that there
are 100,000 shares that people are willing to buy at .014 and only 100 shares
that people want sell. This is a situation where bids are “stacked” meaning
that a lot of people want to buy and few want to sell. This causes the PPS to
rise. However, the opposite situation may be true. Let’s say that after you
bought at .013 the bids show 10,000 at .012 and 50,000 asks at .0125. This
situation means that now people don’t want to buy until .012 and people are
wanting to sell at .0125 (a price lower than you entered in). This typically
means that a sell-off is going on and that PPS is on the decline. When traders see
this action going, a bearish market trend occurs and the PPS can drop
substantially until it reaches support1
.
Level 2 is a tool that would give you greater insight as to how the market is
going. Stacked bids are better than stacked asks.
5.
Use Charts
Charts are visual depictions of how a stock PPS has
performed over a certain period of time. They can be very helpful as they may
show trends. Continuing with the example of the stock you bought at .013. Let’s
say you looked at the 5 day chart and saw that just two days earlier this stock
was trading at .002. This means that in the last two days the stock has risen
650%. At this point, you likely would not want to buy this stock at .013
because usually typically penny stocks have a fast rise but normally go back to
their original PPS. In this example, if you bought at .013 your share more than
likely would drop to .002 area.
Contrary, the chart could show that the price is at its lowest in the last 6
months. Couple the chart with Level 2 to see if there is support at this
current level and bids are stacking, and it may be a very good buy as the PPS
could shoot up and you can meet your 30% trading rule profit level within a
matter of hours.
(this is a 3 month chart, depicting somewhat steady
growth, notice that the stock has almost doubled since July 7th.
However, in the penny stock world this may be considered a good growth rate)
6.
Do not Short as a beginner – especially not a penny stock.
Shorting, in my opinion, should be reserved for
experienced traders with access to Level 2.
Shorting a stock –
This is a trade initiated because you expect the PPS to drop. For example, a
specific stock X is trading at $50 and you believe that soon the stock will
fall to $40 and therefore you begin a short position. This means that you
“borrow” shares and sell them at $50 PPS. Now assume you shorted 100 share at
$50. Upon beginning your position, you now have $5,000 in your account. The
next part is to “cover” the shares you shorted because they were not yours to
begin with. Let’s say that you were right and the PPS dropped to $40 at which
point you bought the 1,000 shares and “covered” your position. The short trade
is now complete and you have made $1,000 on this trade. Shorting is not advised
because success requires you to be a much disciplined trader as there is a
limited gain possibility (stock an only drop to $0) versus unlimited loss
potential (stock can go up to $1 billion).
7. Do your own research and do not blindly
follow other trader’s advice.
You should always
perform your own research on a company or do your own analysis of the charts
and level 2. Most penny stocks are continuously being pumped1 and therefore it is in your best interest to
take your trades in your own hands.
Until recently, my
Due Diligence (the level of effort you had put into researching a stock to
determine whether or not you should buy the stock) had mostly consisted of
other peoples posts. This is not advised as key information can be missed.
8. Do not trust what company management puts
out.
As mentioned earlier,
penny stocks are highly subjected to scams. Therefore, blindly listening to
company management can lead you to hold a stock even if the PPS is decreasing. You
should focus more on the actions of management rather than their words.
For example on June 10th $DNAX retracted
a PR (Press Release) that it had distributed the prior day stating that “Trenton
Coca-Cola” was going to be the distributor of their products. This caused the
stock to rise 525% that day. This was the statement the company put out on June
10th “Trenton Coca-Cola has not agreed to distribute any DNA
products. I apologize for this misunderstanding. We pride ourselves on our
integrity, especially in making public announcements concerning our business.
It appears that in this instance I got it wrong” The public announcement also
referenced a quote from “Chuck Jones who was purported to be the president of
Trenton Coca-Cola. He is not”
Moral of the story, don’t blindly trust. On June 10th,
the stock ended up almost at the level where it started on June 9th.
Terms
Defined
Bullish – The verb of a “bull market”
defined as a financial market of a
group of securities in which prices are rising or are expected to rise.
Bear market - A market condition in which the prices of
securities are falling, and widespread pessimism causes the negative sentiment
to be self-sustaining
On the market – to make a purchase as the price of a share fluctuates.
This Matches your purchase with any sellers at that specific point in time.
Bid – The amount a stock is being bought for
Ask – The amount a stock is being
sold for.
Support – A level where traders will not allow the PPS to fall
below.
Resistance – A level of PPS where
sellers have established that they have reached their levels of profit and are
selling the stock at these levels. This causes the PPS not to go above this level.
Pumping a stock – can be paid or by traders with positions in
that PPS that will benefit from an increase in PPS. This is an action of where
a stock is being positively advertised and gives the impression that large
gains will be incurred if a position in the stock is purchased. This is
typically lead by a dump whereby the original pumpers dump their shares. This
leaves victims holding higher priced shares. This is called “Bag holding”
Bag Holding – Being the victim of a pump whereby pumpers have advertised the
stock and then sold leaving you with high priced shares with the PPS on the
decline.
Long – Being long in a stock is like “marrying a stock” meaning
you expect the stock not to be a penny stock. This is typically not a good
idea.
Day trade – not being long on a stock.
