Advanced StrategiesUnderstanding Penny Stocks

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Volatility Play Investing II

4. A good Volatility Play penny stock will almost always have an obvious price level where traders tend to cash out and take profits.

Unlike a support level which may or may not be at a threshold number (like $1.00), resistance is almost always at a threshold number for penny stocks.

While a penny stock without a resistance level may just keep rising over time, the difficulty is that you will not know when to take your profits. You will see that a stock without a clear resistance level could reverse on you at any time.

5. A potential Volatility Play also needs good daily trading volume.

Look for stocks that see an average of 50,000 or more shares trade hands per day, rather than averages of 20,000 or 8,000, or 1,000.

Volatility Play penny stocks may not hold their pattern for very many cycles, and can break free at any time. You will benefit more by your ability to pick good Volatility Plays than you will by trading well.

Identify more Volatility Play penny stocks than you will be investing in, with the theory being that you watch the entire flock. Most Volatility Plays will only be in a buying opportunity about 5% of the time. You buy into the ones that approach their support levels while passing on the others that are not reaching your targets.

Timing

The best time to buy is right after the penny stock bounces off of the support level you delineated (which also affirms your choice of support price).
The second best time is to buy right before the stock hits support, but is trading at only a fraction above the support price. The problem with the latter choice is that you will be subject to those situations where the penny stock sees the support level fail, and the price falls right through to lower levels.
The best price to acquire shares at is just above the support price. For example, if support is at $1.10, you may want to acquire shares at $1.15 or even $1.12.
The best time to sell is just before the stock reaches the resistance level. Drops from profit takers can be quick, so it is usually more effective to sell too early than too late.
The best price to sell is just below the resistance level. For example, a $2.00 resistance is best sold into at $1.95. (Or even $1.85 to be safe, especially if the penny stock has a history of collapsing back to former levels very quickly).

When investing in this fashion, make sure to factor in the fact that you will be taking more frequent commission charges from your broker.

Also, make sure that the range of volatility is enough to support profits, because you may be buying and selling in a tight price range of only 15% to 40%. If you are making 15% profits on a few hundred dollars, you may only be breaking even after paying trading commissions and taking the occasional loss

Make sure that the changes in price direction and the degree of price activity are not based on fundamental factors like news releases, changes in financial performance, or other factors mentioned in the discussion on Fundamental Analysis detailed in Chapter Three of Understanding Penny Stocks. A company may have been a great Volatility Play, but if it gets a huge FDA approval, the trading ranges can get thrown out the window.

Also remember that you do not necessarily have to sell all of your shares each cycle. This applies even more so if you are not positive about the upper resistance threshold, or you are not even sure if the stock will follow your volatility expectations. You could sell half or a portion of your position, and leave the rest to ride.

As well, you may benefit by gradually increasing the amount you invest in each cycle. If you have made some profits and have a good feel for the stock, and the support and resistance levels have proven out near the prices you expected, you may want to put more cash onto the table.

A Note About Jumping Ship

If you have pegged a stock's support level at $1.00, and the price breaks through that level, you can know that perhaps:

Your choice of support level was wrong
The stock is not a Volatility Play after all, and the concepts presented in this section do not apply
Some fundamental or technical factor has arisen which has forced a failure of the support level

In any of these cases, it is best to liquidate your position as quickly as possible, trying to take only a 5% to 15% loss. If you hold every Volatility Play that sinks past your support levels, you will eventually wind up with a portfolio of sinking ships.

The beauty of Volatility Play investing is that you should be taking frequent profits, so the strategy allows for some losses in the interest of the overall picture.

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