Advanced StrategiesUnderstanding Penny Stocks by Peter Leeds

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Penny Stock Day Trading

This section is meant to give you an introduction into the world of day trading.

Day trading is an effective way to make profits on the penny stock markets. It is not difficult to start doing, and by keeping a few key points in mind you may be able to begin turning a profit within a few days of starting.

Before we begin, know this: True day-traders are involved in options and derivatives, which are more volatile and risky than penny stocks and more conventional equities. Thus, it is not possible to "day trade" penny stocks based on the literal definition. However, it is possible to make profits on penny stocks on a day by day basis, especially due to their volatility.

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Day trading penny stocks requires that you follow many stocks (most of these will not make any significant moves from day to day, so it is better to have a whole portfolio of shares to increase your choices at any given time).

Each of the stocks on your 'watch list' needs enough trading interest (daily trading volume of at least 50,000 shares), and volatility (Beta factor, as described in the previous section on Trading Windows). Note that some penny stocks may have plenty of activity and volatility on a day to day basis, but it can always dry up overnight. Look at average trading volumes over a longer time frame, to make sure that the stocks on your Watch List meet your needs.

Requirements of Penny Stock Investors

You should not get involved with day trading unless you are able to effectively monitor your holdings and can commit with the proper mind set and outlook. This strategy takes time, research, and a good deal of money (I suggest at least $4,000). Otherwise, you may not be able to benefit from such a trading methodology.

You need to be able to check the prices of stocks on a moment's notice, and get an accurate and up-to-the-minute quote. Having internet access or a computer connection to your broker from work or home is generally best. When day trading, you may need to check stock prices frequently, possibly watching their prices all day. Using a computer it takes only a few minutes each time, you can get current prices, and can alter or submit new orders on-line after checking the penny stock's activity.

Most of all, you need patience. Although day trading in penny stocks is probably the quickest profit and loss method in the financial world, patience still comes into play. The best day trading strategies involve often going a week or so without a trade, because you must wait to get the best prices. Impatience immediately negates the effectiveness of the day trading strategy.

Finally, you need a strong stomach. You should understand that day trading in penny stocks can result in one week gains that are monumental, or can set you up for a loss. Whether making a big profit or taking an ugly loss, you should be able to handle both the good and bad stress that will come with this method of trading. Otherwise, you may make moves for the wrong reasons and compromise your objectives.

What Day Trading Is

Day trading is simply an attempt to capitalize on short term fluctuations in stocks. For example, with penny stocks it is possible to buy an issue at $0.12 and sell it the next week, day, or even a few hours later at $0.15, giving you a 25% short-term profit on your investment.

If a profit of more than 20% to 25% presents itself, you often take it. Do this a few times and you are looking at a highly successful investment strategy.

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The downside of day trading comes into play when you buy an issue and it drops in value. At that point you either take a quick loss to keep your money available, or you sit and wait for a profit opportunity that may arise later, in which case your money is tied up until that time. This becomes less of a concern for traders who have more assets at their disposal, because while only a portion of their money is temporarily tied up in a stock that has fallen in value, the rest of their portfolio could be actively used.

Now, let me tell you how to take advantage of day trading without significant risk, and with maximum profit potential. If you are going to begin day trading, read this section a few times through and adjust your own investment style accordingly.

Goals of Day Trading

This is very important if you intend to be successful at day trading. Your overall goal is to make several hundred of percent on your investments on a year by year basis. However, this is to be done 40% and 30%, even sometimes 10% at a time. That is where most day trading strategies fall apart - investors donít understand that taking the smaller gains more frequently will actually be more effective than the larger gains less frequently!

Your goals for an effective day trading strategy should be as follows:

  • Keep on top of your open buy and sell orders, and the trading activity of the underlying stocks so that you are rarely surprised by a penny stockís action.
  • To take small profits when they present themselves. You will find that you have the opportunity for small 15-25% profits very frequently.

You wonít often be in a position to be taking the larger 30%-50% profits, because you already would have sold when your shares first began to rise. Therefore, as backwards as it sounds, if you find that you are taking 50% profits more often than 25% gains, you are probably doing something wrong. In the long run, you would likely make more money by grabbing the 25% gains again and again, instead of holding out for the larger returns.

Effective Strategies and Considerations

The first consideration of this trading method compared to others is that you will be taking commissions more frequently. If you are not already with a discount broker, or are paying more than $20 per trade, you probably should switch to a cheaper broker. You can read all about penny stock brokers, and get my list of the top ones earlier in this site.

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With penny stocks, you may often find that a buy or sell order goes partially filled. For example, you may only get $200 worth of shares and be stuck with a $20 commission. To avoid this, keep track of your orders during the trading day - you may pick up a portion of your order at the price you want, then have to adjust the purchase or sell price to make sure you get the rest of the order filled. Changing an existing order to get all the shares you want on one day, instead of over two or three days, means that you will only be subject to one commission.

The beauty of day trading is that company fundamentals and overall market action become less significant. You are playing the day by day fluctuations instead of hoping the market will rise or the company will increase its earnings. Buying at the low end of volatility and selling at the high end equals success, despite monthly trends, company fundamentals, or the market outlook.

Therefore, it doesnít matter if the companies you invest in have a positive future or are bad long-term purchases. Whatís important is that you keep an eye on the trading activity of the issue in question, try to pick its higher and lower trading ranges, then execute buy and sell orders accordingly.

With day trading you need to realize that most of your buy orders should go unfilled, because your bid price needs to be lower than the going trading price of the stock. Buy on the dips and you will have success - put in orders to acquire shares at or below the current bid price. If you put in ten buy orders over the course of a month, you may wind up only getting one of the buys you had wanted, but those shares will be yours at a great price, making it easier to unload them for a quick profit.

When tigers hunt, they only catch a meal one out of ten attempts.

Deciding on appropriate buy and sell prices at which to submit your orders is relatively simple. Look at a stock that has both high volume of bid lots, and high volume of ask lots. Many people are trying to buy at one price and many people are attempting to sell at another. Look at the spread between the bid and ask prices. If it is about 15% or more, you may want to put in a buy order at the bid price, and if it gets filled immediately put in a sell order at the ask price.

Of great importance is the number of bid lots compared to the number of ask lots. There is a very different stock price outlook if the number of bid shares vastly outnumber the ask shares, or vice-versa. The more bid lots, the greater the buying pressure and price strength at that level. In other words, if there is a large level of demand, the price will likely solidify at that level and begin to climb, unless there are enough shares for sale to meet the demand.

When getting a stock price quote, look at the number of bid lots and ask lots to get an idea of the demand and supply. This will give you a relatively accurate indicator of the direction the penny stock price will travel in the day, and perhaps throughout the following few days. Use the bid lot and ask lot volumes to help you come up with a price range that the penny stock will trade within.

Day trading will prove most effective when you trade in penny stocks that you have been watching for a long time. You will be able to produce better results since you have developed a feel for the upper and lower price ranges. This is not a requirement for success, but rather an advantage.

Hedging and Averaging Down

As a more advanced strategy, you may want to incorporate hedging into your day trading practices. When buying, this involves putting in buy orders for the same stock at different prices.

Let's use an example: You put in an order to buy 4000 shares of OCN @ $0.23 and a separate order to buy 4000 shares of OCN @ $0.17. Now consult the chart below to see the possible outcomes of your strategy.

Possible Hedging Outcomes

  • Outcome #1: If the price falls to or below $0.23, your first order gets filled. Now if the price drops further, you may get your second order filled at a lower price, averaging the price of your 8000 shares to $0.20. Profits could be realized now by selling at $0.22 or greater. If the price climbs, you will make a profit. If it continues to fall you will take a paper loss. This becomes an actual loss if you sell the shares, or if the shares never return to their $0.22 levels. However, in all likelihood the price will bounce around and will present an opportunity to profit or at least break even at some point in the future.
  • Outcome #2: The price falls to or below $0.23 and your first order gets filled. The price then rises, leaving your second order unfilled, but providing you with the ability to profit on the 4000 shares you did buy.
  • Outcome #3: The price does not fall low enough to fill your buy order. You donít get the shares, but you are no worse off. You can extend your order, adjust your prices, or move on to a different penny stock. Again we must stress that an unfilled buy order means that you probably have the right idea. It is better to have an unfilled buy order than to get shares at too high of a price.

These hedging strategies can also apply in the same manner when selling penny stocks.

Of course, you are also getting exposed to extra commissions with this strategy.

Day Trading Summary

Day trading penny stocks is as straight forward as it sounds. However, you will need a little luck, a lot of patience, and the ability to take the profits that present themselves. By keeping a close eye on the markets and following a simple strategy such as the one outlined above, day trading becomes a straight-forward technical process that requires little thought, yet can provide impressive penny stock returns.