Tuesday, July 29, 2014

Penny Stock Guide and Tips - Beginner

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.

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