Penny Stock Trading: How to Tell When a Penny Stock is On the Rise

Let me tell you, creating titles for these penny stocks posts is not always easy…especially as much as I ramble. I can go from AMEX to short selling to earnings per share to technical analysis all in one post, and most of the time it can be in the opening paragraph alone (LOL). The reason why I mentioned this is because I was debating about what to title this post, and it’s actually a bit of a misnomer. The reason why I say this is because it’s not always accurate to say that I can tell when a penny stock is “on the rise”, necessarily, but rather I can tell when one is about to “pop”. That’s the best way I can describe the price action of penny stocks (well, at least the ones I target anyway), is that I invariably identify penny stocks that are given to a quick “spike” in price, usually followed by an equally fast (or even faster) drop in price. This isn’t something that I can predict, but it’s something that I have learned over time, just simply by being in enough trades and examining and analyzing enough price charts. Such is the nature of penny stocks; if you’re expecting some type of long-term capital appreciation with micro-cap stocks, keep dreaming, dude. Most of the time penny stocks are just going to “blip” up and then quickly fall back down…the key is to first recognize all of the right price action by studying a stock’s price chart, and then to be in the market when you see all the “symptoms” of a potential move taking place. Believe me when I say, no truer words have been spoken about price action than what the legendary technical stock trader Ted Warren said in his book “How to Make the Stock Market Make Money for You”—“There is no greater proof that a stock is going to rise than when it acts as if it can’t”. Sluggish price action, though it may seem counterintuitive to believe this way, is actually a good sign that a stock is gaining technical strength. Look for a tight “channel” of price activity, where there are clearly defined support and resistance points. Look for volume to be slightly on the quiet side, with not too many spikes up or down, just a steady flow of volume, often in only the 100,000 shares or less per day range (even for lower priced stocks). A good thing to note is that the longer the stock stays in this type of quiet, narrow range of price action, the stronger the stock’s technical foundation is becoming, and the more upside potential the stock will have when it’s finally time for it to “make its move”. I have found that the longer I had to wait for a stock during its accumulation phase (that’s what the time period is called where the stock trades in a narrow price range), the more it was worth the wait when it came time for the stock to move.

The Four Phases of a Price Move in Penny Stocks

All penny stocks that are candidates for increasing in price will go through each of the following four phases: The Base, the Rise, the Distribution, and then the Decline. This is a very rough paraphrase of what is taught in Ted Warren’s book. Basically, when a penny stock is in the Base phase, it is undergoing price action as described in the previous paragraph. There doesn’t seem to be too much going on with the stock, it’s just kind of humming along, not making any waves, not being touted by any investment analysts, not even making headlines. As a side note, it’s funny, but as you study price charts, you’ll be amazed at how you can see a price move coming long before the company releases some exciting “announcement” that sends the shares skyrocketing. Don’t ever think that any of this hype catches the insiders off guard. Again, the very fact that analysts even mention whether or not the “public is in the markets” proves that there is someone else BESIDES the public in the markets. But anyway, this quiet action where the stock is just humdrumming along, trading day in and day out in a very uneventful manner, is a good sign that the Base phase is in effect. This is also known as the Accumulation phase. Technical strength is being built during this phase, and if the setup is right, the Rise phase inevitably comes next. This is where there is a slightly gradual increase in prices, even preceded by a one-day “pop” outside of the stock’s normal trading range. This is designed to pique the public’s interest. Once the stock starts showing some “signs of life”, public interest increases in the stock, many times to the tune of millions of shares in a matter of days. Of course, by this time, objects in motion tend to stay in motion, so therefore the Rise phase is followed by an outright frenzy, with the public snatching up shares sometimes regardless of the price they have to pay—after a while, they just want to be “in” the stock, because it has all of a sudden become “cool” or “sexy” to do so. This feeding frenzy leads to the Distribution phase, where the insiders are now selling all their shares, gladly handing them over to the unwary, amateur public investors (really speculators and gamblers), and then what’s left is the Decline phase, where the party is over and, as usual, the public is left holding the bag, as the stock’s price begins to decline, leaving most speculators disillusioned and less confident than ever. It’s all based in greed, hype, fear, and a pretty darn remarkable understanding of mass psychology.

The old adage is very true: If you’re hearing a bunch of hype about how “hot” a particular stock is, you’re already late to the party. I want to go into this aspect of penny stock trading in a little more detail in my next post, and hopefully we’ll get a chance to examine one of those cool fax blasts that tout the latest penny stock, and really examine the psychology behind the whole deal. Until then, keep trading penny stocks, and don’t be your own worst enemy---trust the CHARTS!