The Best Penny Stock Principles: Sustainable Momentum
Here is the first installment in our Best Penny Stock Principles series.
“What does good momentum look like in a penny stock?”
This is one of those questions I get all the time. And there’s more than one answer. But I thought I’d take a shot at giving some examples of how to think about these stocks.
I want to introduce you to a concept I call “Sustainable Momentum”.
It’s a critically important concept for Penny Stock or Low-priced Stock Trading. Basically, anytime you have a market capable of making extremely large percentage moves and potential strong variation in market book depth, you will have to consider the sustainability of any strong momentum trending action.
A lot of so-called gurus use momentum and volume basically in a vacuum. Here’s the problem with that: If there’s nothing but promotional pushes out there propping up the movement, then there will always be that last ditch point when the tippy top of the mountain is put in place.
What do you suppose momentum and volume will look like at that point?
You guessed it… Never better. That’s right: Pump and dump moves generally have their most impressive momentum/volume profiles on basically their last tick of upside.
In fact, this applies to profit taking as well. When you’re in a play that’s working in a big way, you want to wait on the flourish – that is, wait for the momentum and volume to both spike hard at the same time. That’s the upward ‘capitulation’, and it’s time to get that money into the bank.
The converse is also true: If you see a big move higher – no matter how big – you don’t want to bank the whole position while you are still seeing grinding, gradual pace of momentum and volume.
By analogy, if trends were classical music, you would want to cash out the position when the big crescendo leads to the final statement of the closing theme, not during the plodding rhythmic dance.
If trends were foot races, you would want to close it out on the final exhausting sprint at the finish line, not during the steady jogging pace in the middle.
Grand finales, sprints, and capitulations aren’t sustainable. But jogging and plodding along is. Understanding the difference, even in an abstract sense, can add an extra decimal point to your profits in any trade.
The key chart tools to apply are your basic volume histogram and either MACD or RSI indicators, along with bar range values.
When you see the volume over the past 5 bars exceed the volume average for the day by at least a factor of 2:1, then you may be seeing capitulation.
Similarly, if you see a spike in swing highs in MACD or RSI that more than doubles the prior swing on the current leg, you are likely seeing capitulation, especially if you’re seeing spiky action and significantly bigger bar ranges.
The key in both cases is that the diagnosis is a Relative process, not an absolute one. It’s important to keep this in mind.
In summary, the fact that volume and momentum are impressive doesn’t mean much in and of itself. You want to buy sustainable momentum, and sell on unsustainable amplifications that stand out by a multiple factor on a relative basis in terms of volume, momentum, and bar range.