The technical indicator called Stochastics is used to determine patterns of uptrends and downtrends in a stock’s trading pattern. The oscillation of the Stochastics shows you when a stock is nearing or within an oversold area or nearing or within an overbought area.
Stochastics come in two main varieties, fast and slow. Both are graphed between 0-100, where over 80 means overbought and under 20 means oversold.
The Stochastic Fast is charted using the following two lines.
Fast %K: [(Close - Low) / (High - Low)] x 100 (shown as black line above)
Fast %D: Simple moving average of Fast K (3-day MA) (shown as blue “trigger line” above)
The Stochastic Slow is charted using the following two lines.
Slow %K: Equal to Fast %D (3-day MA of Fast %K) (shown as black line above)
Slow %D: Simple moving average of Slow %K (shown as blue “trigger line” above)
Which is better? Well, the Stochastics Slow is usually preferred by most traders because is does not show as many false buy and sell signals.
Stochastic Price Divergences
One other aspect of Stochastics that I would like to touch on are Stochastic Price Divergences. This occurs when the Stochastics begins to oscillate within a smaller and smaller range. If the narrowing range is encompassing high numbers around 70 and above then this is a very strong bullish signal. The opposite is also true, if the narrowing range is encompassing low numbers below 30 then this is a very bearish signal.
Below is an example of a bullish Stochastic Price Divergence.
When used with other stock indicators the following charting skills can help you greatly improve your trades.
Resistance levels are price levels that a stock has a difficult time busting through. The bottom resistance is called a floor. The upper resistance is called a ceiling. Typically, buyers enter the market around the floor price to stabilize the price and possibly drive the share price back up. When a stock is reaching its ceiling, sellers will enter the market stopping the upward momentum and even driving the stock price back down. The best way to spot resistance levels on a stock chart is to find prices where the stock moves horizontally. For example, if a stock is trading around 15 and then trades down to 10 but then begins to move sideways at 10 and eventually heads back up in price, then 10 is probably a price floor. The more times a resistance level is tested, the stronger it becomes . However, if a resistance level is broken it usually results in upward momentum. For example, if the stock mentioned above broke through its price floor of 10 then the price floor would become the price ceiling. Keep in mind that resistance levels are usually price ranges not a specific stock price.
Another important feature of stock charts is volume (the number of shares traded each day). Most stock charts will show the volume of shares traded along the bottom of the chart. Look for higher than normal trading activity. If a stock is trading higher on high volume it is much more likely to continue. However, if a stock is trading higher on low volume, it may be a sign of uncertainty and the gains may be short lived. Without the conformation of volume it is very difficult to be sure of any price move or new trend.
A gap is when a stock “jumps” up or down leaving a blank area on a chart. For example, if a stock closed the previous day at $12 but opened the next day at $14, this would be a gap up. In this example the gap will become a resistance floor. However, if the gap is penetrated, it will often fill the entire gap or close the blank space before resuming its trend. Once the gap has been closed it loses much of its significance on stock charts.
Here’s a quick clip for all you beginners with some very basic, but important information about reading stock charts:
Using stock charts can be a helpful tool. However, stock charts use historical data and future price movements may differ. Most active traders rely heavily on stock charts and indicators to make their investment decisions.
In U.S. financial markets, penny stocks commonly refer to any stock trading outside one of the major exchanges (NYSE, Nasdaq, or AMEX), and is often considered very risky.
In the UK, penny shares as they are more commonly called, usually refer to a stock and shares in small cap companies, which is defined as being companies with a market capitalization of less than £100 million and/or a share price of less than £1 with a bid/offer spread greater than 10 percent. In the UK Penny Shares are covered by a standard regulatory risk warning issued by the Financial Services Authority(FSA).
Trading penny stocks is the easiest way to make the large profits with the least amount of startup capital. Why? Because of their volatility. It’s a lot more difficult to find a $50 stock that goes up 100 percent in a short time, but there are hundreds of penny stocks that go from a penny to two cents, a dime to 20 cents, or a dollar to two dollars in a matter of days.
There are risks associated with trading penny stocks. In many cases these risks can be mitigated or avoided altogether, but there is always the chance of losing money.
Penny stocks have a bad name, because scammers use thinly traded shares to take advantage of people, with pump and dump schemes, and by providing manipulative information. Penny stocks also get a bad name because many investors lose money trading them, when they don’t understand what their investing in, or how to trade these penny stocks. Many people trade penny stocks before they learn about the easily avoidable dangers, and then complain that penny stocks are dangerous. However, for those investors who do learn how to find good quality companies, and take the time to understand the dangers and how to avoid them, there are tremendous profits to be made.
During a ten year period between 1993 and 2003, the growth in the volume of shares traded on the OTCBB — almost entirely comprised of penny stocks — eclipsed trading volume on the Nasdaq and NYSE (See Figure 1).
Figure 1: Volumes for the Nasdaq and OTCBB. OTCBB volume grew 8900 percent between 1993 and 2003, eclipsing both the Nasdaq (638 percent) and NYSE (512 percent) volume increases by a wide margin.
Volumes on the Pink Sheets have grown even faster. In 1998, about 9 billion shares traded, and by 2003, volumes had surged to 187.5 billion–an incredible increase of more than 2000% in just five years. (See Figure 2).
Figure 2: Rise in trading volumes on the Pink Sheets
How do you trade penny stocks? Are there any techniques that work best?
Technical analysis that uses indicators and statistics to predict price movements is one possible approach, according to Investopedia. But due to the rampant growth of the penny stock phenomenon, technicians haven’t had the time to build a strategy–assuming anyone is interested in coming up with one. As far as analyzing sub-penny stocks, it would require a new system for charting and monitoring to determine the significance of a 0.0001-cent move, and there is no telling whether or not it would work.
I recently watched an interview with Tim Sykes, the author of An American Hedge Fund. Sykes, who’s in his mid-20s discussed a few reasons why your 20′s may be a good time to explore the volatile world of micro cap stocks.
Here’s the interview:
Now, before you get too excited, there’s a lot of downside to playing penny stocks.
Investopedia.com has a great primer for anyone interested in highly volatile penny stocks.
According to Investopedia, there are four main reasons to be leery of penny stocks:
1. Lack of reliable information available to the public: The key to any successful investment strategy is acquiring enough tangible information to make informed decisions. For micro cap stocks, information is much more difficult to find. Companies listed on the pink sheets are not required to file with the SEC and are thus not as publicly scrutinized or regulated as the stocks represented on the NYSE and the Nasdaq exchanges; furthermore, much of the information available about micro cap stocks is typically not from a credible source.
2. No minimum standards: Stocks on the OTCBB and pink sheets do not have to fulfill minimum standard requirements to remain on the exchange. (Read What are the listing requirements for the Nasdaq?) Sometimes, this is why the stock is on one of these exchanges. Once a company can no longer maintain its position on one of the major exchanges, the company moves one of these smaller exchanges. While the OTCBB does require companies to file timely documents with the SEC, the pink sheets have no such requirement. Minimum standards act as a safety cushion for some investors and as a benchmark for some companies.
3. Lack of history: Many of the companies considered to be micro cap stocks are either newly formed or approaching bankruptcy. These companies will generally have a poor track record or none at all. As you can imagine, the lack of historical information magnifies the difficulty in picking the right stock.
4. Liquidity: When stocks don’t have much liquidity, two problems arise: first, there is the possibility that the stock you purchased cannot be sold. If there is a low level of liquidity, it may be hard to find a buyer for a particular stock, and you may be required to lower your price until it is considered attractive by another buyer. Second, low liquidity levels provide opportunities for some traders to manipulate stock prices, which is done in many different ways – the easiest is to buy large amounts of stock, hype it up and then sell it after other investors find it attractive (also known as pump and dump).
Even with all the risks associated with penny and micro-cap stocks, there is a lot of upside if you choose the right ones to get behind.
Here are 3 Penny Buzz Stocks that we think are worth keeping an eye on:
Glowpoint, Inc. (OTCBB:GLOW): If you’re an avid ESPN viewer, you’ve probably seen Glowpoint’s technology at work. The company provides high-quality video conferencing technology to media companies. Trends like high definition video on the Web are creating a lot of opportunities of Glowpoint to grow its customer base, and develop new solutions. The company has a trailing P/E of 7.8, and has quarterly (yoy) revenue growth of 4.5 percent. Glowpoint has about $1.7 of cash in the bank, and earned about $0.51 per share last year.
Soyo Group, Inc. (OTCBB: SOYO): This computer, and consumer electronic products maker just unveiled 20 of its newest products at this year’s Consumer Electronics Show including bluetooth adapters, external hard drives, and HD TVs. The company’s Honeywell line of HD TVs is also being sold on Feb. 7th on HSN this Saturday. 9, Management projects total revenue will be approximately $110 million, with approximately $2 million in profit and $0.04 earnings per share.
Goldspring, Inc. (OTCBB: GSPG): Hard assets like gold and silver could make a comeback this year in light of the shaky global economy. The company just announced test results that revealed strong gold and silver mineralization in the deposit at the Hartford Complex in the Comstock Lode District of Nevada. The stock could be primed to make a run in the next few weeks, as the company is planning to announce
Just remember, penny stocks are volatile and erratic. If you buy a stock at $0.10 and sell it at $0.15, that represents a 50% return on your investment. A 5 cent decline, however, would leave you with a 50% loss. Many stocks trade in this range on a daily basis. If your investment capital is $10 000, a 50% loss is a $5000 loss. Do this twice and you’re investment is gone. Keep your stops close. If you get stopped out, move on.