Penny Stock Trading: Are You a Fundamentalist or a Chartist? (Part One)

Before you even begin to trade penny stocks, you must make a decision about where you’re going to get your information from. What I mean is (in question form), what information are you going to use to base your trading decisions on?

There’s really only two major categories of trading philosophies out there, and which one you pick will determine what you’ll base your trading decisions on. In the world of stock market investing, you’re either going to be a fundamentalist or a chartist. There are some “hybrid” versions of each, but all trading methodologies generally fall into one of those two categories. So what is the difference between the two?

Fundamentalists rely heavily upon the data that the particular company they’re interested in puts out, such as annual reports, several different ratios (book ratio, P/E ratio, etc.), earnings per share, the product or service that the company offers, accounting information, historical reports of the company’s performance, who the management team is, future business projects and prospects, on and on. You know, the type of stuff you would see in the company’s prospectus. Most of this data is basically concocted by people whose sole purpose is to make the company look good enough to attract new investors.

In my mind, none of the above information counts for too much as far as determining how high a stock’s price may rise. What does it really tell you? Nothing, except what those that have a vested interest in the company want you to believe. Truth be told, most company’s numbers are terribly inaccurate, and are “fudged” to fit whatever seemingly plausible scenario the company’s officials feel needs to be presented. “Cooking the books” happens in companies of all levels, and I believe it would be further magnified in a microcap company with more abstract accountability standards. It’s just like that old joke about the company CEO who was interviewing people for his top accounting position. He asked the first candidate “What is two plus two?” The candidate replied “Four”, and the CEO instantly dismissed him. Then the CEO asked the second candidate “What is two plus two?” The second candidate replied “Five”. The CEO said “Better, but you’re not getting the job either.” Then, the CEO asked the third candidate “What is two plus two?”, to which the third candidate replied “Whatever you want it to be.” The third candidate was hired on the spot. Believe it or not, this is actually what goes on behind the scenes. Keep that in mind when you’re reading a company’s annual report; accountants are able to work some serious magic to turn liabilities into assets on paper. Not all accountants are bad, but when you’re talking about millions of dollars at play, it’s easy for some people to lose all sense of ethics. So when it boils down to it, for you to believe in fundamentals, you’re basically taking someone’s word for how good the company is. And they could be lying.

The absolute BEST book I have ever read on the subject of stock market investing is a book called “How to Make the Stock Market Make Money for You”, by a gentleman named Ted Warren. For me to get into Mr. Warren’s history would take an entire separate post (and maybe series of posts), but suffice it to say, he was one of the most successful stock traders of the 20th century. He had an understanding of the markets, and what makes the stock market tick, that was truly uncanny, and his book explains in precise detail the methods and principles that he used and traded by. It completely changed my understanding of stock trading, and actually (and finally) set me on a successful course, when before I was pretty much just languishing and not making SQUAT worth of profits from the stock market.

I mentioned him here because I wanted to quote a section from his book that perfectly illustrates what I’m talking about. Please read on:

“Are you capable of weighing all the known fundamentals against one another? After all, some may be bullish, some bearish. It is the unknown factors that are important, because they are unknown to you until it is too late. The groundwork of plans for expanded business or a money-making product may take place years before you and I are aware of it. Those in the know, you can be assured, are also building the groundwork for a large rise in the share prices of their company by maneuvering their stock through an accumulation phase [see my post about the ‘Pump and Dump’ for more info on the accumulation phase] which may be easily detected by its price action.”

And how would you be able to detect a penny stock’s price action? Bingo—by looking at its price chart. So you see, you really don’t need too much else when trading penny stocks besides an online brokerage account and some decent price charts.

I hate to say this, but I gotta run for now...I'm going to have to pick up with this topic on my next post...don't let me lose my train of thought!