Penny Stocks About to Take Off

If there’s one thing that small cap & microcap investors will give their left arm for, it’s the ability to identify penny stocks about to take off. When I think about what it really takes to make this happen, I’m always reminded of Ted Warren’s words in his iconic book “How to Make the Stock Market Make Money for You”—“It’s only when you’ve mastered the art of hindsight that you can master foresight.” It’s so true—history does repeat itself, and one of the primary ways that this is proven in the stock market world is by looking at historical price charts. There are, whether people believe it or not, very predictable and recognizable patterns that appear on price charts, that when followed and understood properly, can position you with a much higher probability for profit upon entry than just ascribing to the “blindfold me and let me throw darts” method of stock picking. Now don’t get me wrong—history has also proven that monkeys and preschoolers can pick stocks to assemble a decently-performing portfolio, so we all need to keep our egos in check, but what I’m talking about are the old tried-and-true methods of analyzing price charts and looking for common patterns that just so happen to show up right around the time that a stock decides to take off to the upside. Now if anyone has learned that the markets can humble you in the blink of an eye, it’s me—I have been openly humbled on this blog by some of the stocks I picked at the beginning of this year, as a matter of fact. But, for better or for worse, this is the way I trade, and I believe in sticking with the methodology that has produced overwhelming proof (long-term) that this stuff actually works. The methodology I speak of is, of course, learning how to read penny stock charts and how to recognize the “setups”, if you will, that signal a potential move upwards in price.

One of the changes that I have made in recent months, however, is revisiting the notion of not waiting for a breakout before you buy. I have seen several penny stock breakouts that required a very nimble hand, to the point that you could miss it if you weren’t paying attention to the stock within one trading day. I have somewhat moved away from stocks that are so mercurial—maybe because I’m getting older, or maybe because I’m finally getting more patient, or maybe it’s a combination of the two. I can tell you, however, that my recent humbling experience with EFOI—which, by the way, I sold for an ugly loss at $0.8305 back in April of this year—has really made me rethink the whole “buy before the breakout” strategy. My initial thoughts about this were “if you know the stock is going to breakout, why wait?” Well, I thought this way until EFOI pulled a fast one on me and decided to barely break above the $1.25 resistance in late March of this year, and then subsequently sink like a stone in a pond only weeks after that. Hindsight taught me that NOT waiting for a CLOSE above the $1.25 resistance was my downfall. Some people think that closing prices don’t matter, but they matter tremendously, especially in terms of the psychology of the market. If EFOI would have CLOSED at its high of $1.35 on March 29 (instead of closing at its low of $1.20 that same day), it could have drawn much more attention and probably would have enticed some buyers to come out of the woodwork. But alas, it was not in the cards for EFOI. Once it hit my exit point, I had to cut it loose. Actually, EFOI looks like a much more attractive buy at its current price level (around $0.47 per share), especially since it’s been consolidating at this price range for about 2 months now, but at the end of the day, I decided it was better to just move on. Anyway, the lesson learned for me lately has been that it is actually better when you wait for a closing price above the most common level of resistance…you need a convincing break to the upside from a long consolidation in order to go ahead and put your money on the table. In my mind, it’s not convincing if the CLOSING PRICE is not decidedly above the most prominent resistance level.

So when you’re looking for a clue as far as when penny stocks are about to take off, know this—if you see a sideways consolidation for an extended period of time, and you then see some “percolation” happening on the price charts, you know that the time is nigh, but heed my newly-formed advice—WAIT FOR THE BREAKOUT before you buy. This means that you wait until you see a CLOSING PRICE above the most common resistance level. It’s almost like watching those old films of some of the first experiments in aviation—you would see an old propeller plane bobbling up and down the runway, trying hard to take off, but it would sometimes bounce up and down, giving a lot of “false signals”, until finally it caught enough wind underneath its wings for it to stay off the ground, and then eventually fly. This is very similar to how a stock’s price action works when it’s about to take off—there’s a period of instability when it breaks above the usual resistance level that it’s been accustomed to after a long period of consolidation, and then once the stock gets “used to” trading at the newfound price (i.e., it has found the right “lift” from the wind under its wings), it begins to fly. Study your charts, folks—support and resistance may not be the most “sexy” ways to trade penny stocks, but man do they work.