Stock Trading 101

Penny stock trading can be very profitable with the right knowledge and skill. Penny stocks appeal to investors because it allows them to buy a lot of shares for a relatively low price. Also, the price of a penny stock does not need to rise much in order to generate a large profit margin. Here are some tips to help minimize the risk associated with penny stocks and provide higher rewards.

So here’s our crash course on penny stocks we are calling Stock Trading 101:

Select a reputable online broker. You want a broker who checks out with your state’s Securities commission, and preferably a discount broker–one that only executes your orders for a fee. Some reputable online brokers include Scottrade, E-Trade, Ameritrade and Sharebuilder. Some things to consider when selecting an online broker are the features and benefits, commissions, inactivity fees, and minimum funds to open an account.

Never invest too much. Never go “all-in” on any one stock. While this could pay out huge it could also do the opposite.

If you are a new trader who is just learning how to trade penny stocks, be very careful with how much money you put at risk and with how much profit you demand of yourself making with each trade. Start small in both areas and get practice and experience under your hat. After six to 12 months you’ll know far better what you are doing and you can ramp up your penny stock investing.

Don’t forget to follow the same basic investment rule for penny stocks as you would for larger stocks: don’t put all your eggs in one basket. Diversify your penny stock portfolio as you would any investment portfolio. When it comes to the fundamentals, there is nothing dissimilar about trading penny stocks.

Do your research. Learning how to trade penny stocks means learning how to do your own research. Pay attention to published tips and maybe even subscribe to some newsletters, but don’t be controlled by those things. Always think for yourself and follow up every “hot tip” with research of your own.

Broker aside, No Investor should be trading Penny Stocks without a FULL trading platform from your broker or elsewhere. This includes full charting capabilities, instant execution, and most importantly, real-time Level II Quotes.

What are Level II Quotes? In its simplest explanation, Level II is basically the market depth of each stock, ie: how many sellers are on the ask and how many buyers are on the bid, and the prices at which they are bidding and selling at. Trading with Level II quotes is a must-have for any serious trader. Combined with a side panel of the stock’s current “Times & Sales,” Level II Quotes can truly make a difference. We will discuss how to disseminate Level II set ups later.

There are a number of places that offer Level II Quotes. You can actually get them from your online broker: the largest brokers such as E-Trade, TD Ameritrade, and Scottrade all have excellent trading platforms which include Level II, however, most require upwards of $20,000 in your account to use these platforms. If you do not have this type of liquidity, we recommend using Equity Feed or Alpha Trade for real time quotes as compliment to your basic trading account for Level II quotes. Equity Feed is quite costly, but if set up right, it can be the most powerful tool you will have. Additionally, EquityFeed has a news streamer, so as to keep you on top of any news that may create some momentous activity for the price per share.

Join a blog or newsletter. Who can show you how to trade penny stocks in a successful way better than a mentor? Find someone who has already done what you are doing–someone who has had the kind of success that you are dreaming of. This mentor may be a penny stock website, blog, or newsletter. But make sure that your choice in mentors is an experienced and consistently successful one. Yahoo finance, Investors Hub and Hot Stock Market are just a few resources you may want to consider.

Buying on a ‘bounce’ We are known for our big board bottom bouncers. Below is a chart that outlines a typical example of when we alert a stock at its bottom.

Notice how after a great exponential move up, the chart sold-off a bit too drastically. Once the chart bottomed, an expected “bounce” was predicted and that became our entry point. Our trend line from the previous rise was used as a take profit point where, as you see, it began to consolidate again.

Know when to buy and sell. If you are given a pick, the first thing to do is see how much it has gained in the previous few days and to see if there is any volume. For example, you see from looking up the ticker that the stock has gained 200% in the past two days on little volume. In most cases, this is one to stay away from. In another instance, you see that an advertised stock pick has gained just a few percentage points with steady but growing volume over the past few days. This is much safer investment.

Here’s some things to keep in mind when buying:

Always use a Limit Order: Most brokers don’t allow Market Orders. Limit Orders allow you to set the price that you want to buy and sell the stock at. Still, you may see some novice trader make the mistake of placing a market order to sell and take out all buyers at the bid, effectively tanking a thin stock.
Buying and Selling at the Ask: Many don’t realize that when you buy at the Ask price, you are HELPING the stock price to move up! Once that offer is gone from the shares you purchased, Market Makers could move up to the next offer price as they will see there are buyers at the current price. If you decide to place an order at the bid, you are basically hoping someone will sell their shares to you at this price and you may never get filled and miss the action. It is not always a bad idea to bid sit, as you are creating “bid support”, if you believe the price may come down again and you are not willing to buy higher.
DO NOT CHASE – Many people want to buy a stock so badly that they end up chasing the stock as it goes up. When they finally fill their order, they may have purchased it too high as traders who bought shares earlier begin to take profit, effectively lowering the stock price and making you a bagholder. Remember, 90% of the time, a stock will always retrace/dip back to an attractive level for you to grab shares.
Using Stops: Some brokers do not allow you to use stops, however, if you can – it is always a good idea to set your stop loss at the lowest price you are willing to take a loss. You may kick yourself when the stock moves back up and your stop already executed, but remember, there will always be other opportunities and its always best to cut your losses just in case.
Stock Gaps: If a stock gaps up too high in pre-market, Do Not Chase It. Most stocks that gap up will come down again during the day. When a stock gaps up the market makers will usually push it lower starting at this time to try to get investors to panic and sell shares back to them so they can make a profit on any shares they are short from filling orders on the gap. If you like the stock and it gaps up you can usually pick up cheaper shares when the market settles back.
Sell as the Stock Rises: When entering a new trade determine beforehand where you want to get out when the stock has momentum and is on its way up with less resistance. Some may say you should put a Limit Sell Order at the price you want to sell at, however, WE DO NOT ADVISE THIS. Sell Limit orders will show up on Level II quotes and create the impression that there is resistance at that price which may cause traders to panic and sell even earlier. We advise that you keep your sell price in your head and execute when it reaches your target.
Take the money and run. One of the unique things concerning how to trade penny stocks is capitalizing on the high volatility of the market. Penny stocks aren’t financial vessels for long-term investors. You might double or triple your ROI in a mere hour. Don’t apply the buy-and-hold strategy used for Blue Chips and other macro cap stocks. Sell and take your profits. If there is any big difference in trading penny stocks and macro caps, it’s the speed at which you make trades.

The Key is Liquidity. Trading penny stocks can be quite different than trading stocks that are over $1.00. Many times a single trade can drastically influence the movement of a stock and shareholder sentiments on top of that. Since pennies are so volatile, it’s easy to scare off investors with a big sell, or encourage them with a big buy. That’s why the key is Liquidity. That’s where we come in. Instead of having traders spread thin over a vast range of stocks, fighting to be able to get a sell without dumping at the bid, or being forced to pick up shares over a huge spread, we concentrate traders on a single ticker, so that the stock can have the liquidity of a “Big Board” and offer investors more profitable entries and exits.

Do your DD (Due Dilligence) In the penny stock market doing your DD (Due Diligence) can be the difference between making and losing a lot of money. You do not want to buy the wrong stock. We always encourage researching every company you plan to invest in. But what are the key things to look for?

Let’s begin by going over some terminology:

Reverse Merger (R/M): The acquisition of a public company by a private company, allowing the private company to bypass the usually lengthy and complex process of going public. This is generally considered a good thing as it increases shareholder value – especially if the private company boasts good finacials and revenues.
Reverse Split (R/S): A stock split which reduces the number of outstanding shares and increases the per-share price proportionately. This is usually an attempt by a company to disguise a falling stock price, since the actual market capitalization of the stock does not change at all. For example, if a company declares a one-for-ten reverese split, then a person who previously held 20 shares valued by the market at $1 each will then have 2 shares worth $10 each. You will want to stay away from any stock that has recently done an R/S or is preparing to.
Market Capitalization: The total dollar market value of all of a company’s outstanding shares. Market capitalization is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determining a company’s size, as opposed to sales or total asset figures. A high market cap can sometimes be looked at as a negative if the company is not valued equally (ie. by comparing revenues etc) and does not have future potential.
Outstanding (O/S), Authorized (A/S), Restricted Shares: Stock currently held by investors, including restricted shares owned by the company’s officers and insiders, as well as those held by the public. You will want to stay away from a stock with too many outstanding shares relative to its current price. Restricted shares are shares owned that can not be sold on the open market until a specified date.
Float: The total number of shares publicly owned and available for trading. The float is calculated by subtracting restricted shares from outstanding shares. For example, a company may have 10 million outstanding shares, but only seven million are trading on the stock market. Therefore, this company’s float would be seven million. Stocks with smaller floats tend to be more volatile and move quicker than those with larger floats. You will want to look for floats that are not too low and not too large.

For a penny stock, the best place to check the current share structure is at http://www.otcmarkets.com. You will want to make sure the company is current and fully reporting (although this does not necessarily make a stock more or less profitable). Many companies are not updated and do not divulge their entire share structure.

Lets look at an example: Stock currently trades at .003. There are 3 Billion Outstanding Shares and 2 Billion in the Float (about $3 million dollars). This would not be a good investment as the company is probably in dilution mode and you will not see much upward movement.

However, if that same stock at .003 has 100 million outstanding shares and 20 million in the float (about $60,000.), you can bet that this stock will move quite easy on increased interest and volume.

Hope this crash course helps you be a smarter, more profitable penny stock trader. Of course, there are many more resources online to assist you with your research. Happy trading!