Penny Stock Breakouts

Alright, I’ve been looking for a good example of penny stock breakouts, and I believe that I’ve found one in the making here. It’s one thing to see a breakout on a historical chart and to look back and say “Okay, there’s where the stock really took off”, but it’s a whole other deal to see it happening in real time. Now, I could walk away from yet another post with egg all over my face if this breakout never fully materializes, but something (in addition to 9+ years of experience trading penny stocks) tells me that this won’t be the case with the stock I’m going to mention. I had posted on my Twitter feed yesterday about some stocks that I had my eye on, and that I would give more details in a coming post. Well, the price action in one of those stocks in particular has caused me to accelerate my posting efforts, hopefully to catch it in real time, so you’ll know I’m not making this stuff up, nor being an armchair stock prophet who’s only right in hindsight. There is something to be said for hindsight, however…Ted Warren said in his book that it’s only through mastering hindsight that you can master the art of foresight. That’s a very profound statement, and it applies even more markedly so in the penny stock trading arena. It’s kind of like the Bible, you know…”That which has been is what will be” (somewhere in Ecclesiastes). If you’ve seen enough penny stock charts and you know how to recognize chart patterns, you will very easily be able to spot future trends or highly likely trends, I should say. We all know that nobody FULLY knows what the market will do, but just like the weatherman, you can often draw a highly probable conclusion based on past trends. That, my friends, is what reading penny stock charts is all about. It’s when you can spot an opportunity that is LIKELY to happen, but not guaranteed to happen, and capitalize on it, if it plays out as you had predicted. Anyway, the stock in question I’m referring to on this post is Energy Focus, Inc. (NASDAQ: EFOI). Take a look at the 6-month chart and you tell me what sticks out to you:



For those of us who are familiar with the different types of chart patterns that have a high probability of success, this one should strike you immediately as a head-and-shoulders bottom. I know I haven’t formally taught this on this blog, but for those who are unfamiliar with a head-and-shoulders bottom, just imagine someone standing on their head. If you scanned their body from left-to-right, you would see their left shoulder first, then their head, and then their right shoulder. The way this is represented on the chart is by rounded-out lines that look like an upside-down head and shoulders. In the case of EFOI, the first shoulder (the “left shoulder” if you will) happened from mid-October to mid-November 2010. The lows hit were right at the $1.00 mark. Then, the head is quite wide, but it’s a head nonetheless, lasting from late November 2010 to early January 2011. The way you know it’s the head is if the lows are lower than the “shoulder lows” (hope I didn’t lose you on that one). In the head, we hit lows of $0.90 repeatedly during December 2010. For those of you who have been reading this blog for a while and remember my post about trading support and resistance, you should conclude that $0.90 is a solid support level for this stock. It’s basically the market’s consensus that the price should not go lower than $0.90, because that’s the perceived value of the majority of opinions about that stock. Then, we have the second shoulder (the “right shoulder”), which occurred all throughout the month of February this year, where the stock repeatedly hit lows of $0.98, but never seemed to go lower. This persistent revisiting of the $0.98 level is somewhat suspicious to me. Notice also that the volume during the head and shoulders of this formation was always somewhat low-key…meaning, volume was lowest when the stock was lowest during this formation. That’s a serious sign of technical strength. Now, take a look again at the 6-month chart, to give us a clearer picture of the “neckline” of this formation:



For those of you playing along at home, the neckline should be screaming at you right about now. It’s definitely the $1.20 level. That’s the level that has not been seriously breached in over 4 months. Yeah, there were a few “peeks” above $1.20, but no serious technical damage was done to that level of resistance. As you can see from the 1-year chart below, this has been quite a strong accumulation pattern overall for EFOI:



So here’s my unofficial analysis for whatever it’s worth: We won’t see any real fireworks until the $1.20 level is convincingly cracked. This includes a strong close above $1.20. When the $1.20 level is convincingly breached, we will have what is known as a “breakout”. What happens from a breakout is basically an object in motion will stay in motion in that same direction (just like physics). Judging from the size and length of this head-and-shoulders pattern, I would say that we have $1.80 in the bag as far as a price target. For all of you math majors out there, that’s a 50% move from the breakout level, which in this case would be $1.20. That’s a very fair and reasonable price target in my mind, and actually it wouldn’t surprise me to see the stock hit the $2.00 level again, just judging from the size of the accumulation. But again, all of this is speculation, and only the market action will prove it right or wrong. I will say this much…I went ahead and got in today at $1.1794, because I wanted to put my money where my mouth is. EFOI has all the right stuff you want to see—a strong chart pattern, quiet volume for the most part, and the appearance of weakness—it just can’t seem to crack $1.20 right now. But again, let me remind you of the wise words of Ted Warren: “There’s no greater proof that a stock is going to rise than when it acts as if it can’t.” That’s poetry, my friend.