Trading Tip: Learn a Stock’s Back Story

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As a day trader, you see a lot of stocks on a daily basis. It is easy to focus on the present movement of a stock and forget that it has a long history. Of course, you analyze charts from multiple time frames, however, this is sometimes not as insightful as it should be. While it wouldn’t be efficient to learn the back story of every single stock you trade, there are certain times when it is appropriate. The first one being for sub-penny stocks or anything under $0.05 trading on low volume.

Sub-penny stock movement confuses a lot of people because they don’t know what drives it. While there are obviously a lot of factors driving the price movement, there is usually one that overpowers them all: the story. If you’ve traded sub-penny stocks before, you must be familiar with “the story.” Every stock has one. It either goes something like “This company is garbage and we are waiting for them to fail” or “This is the next Microsoft. Millionaires in the making here..” 90% of the time, a stock’s back story is as unsubstantiated as this statistic. That doesn’t matter though. What matters is that people tell themselves a story and trade accordingly. Additionally, other people are influenced by the stories of others, which affects price action as well. Read my post on market sentiment to learn more. Learning these stories can help you understand why a stock’s seemingly random movement is actually not random at all. Sometimes movements can be triggered by a post on a message board, a social media update from the company, or an expected news event that was announced months ago. It can be hard to understand this story simply by looking at the press release history, especially if you are looking for recent news. Sometimes a press release may seem like good news, but a stock’s story can disprove that theory or solidify it even further.

Another time you will want to know the back story of a stock is when it is moving upward exponentially. Sometimes this can be due to a pump and dump scheme, positive news, or some other factor, however, learning a stock’s history can tell a lot.

Let me use a simple example to support my point. Last week, I did a post on a stock called HDY because it had a perfect intraday technical breakout. What I missed was that the press release that triggered the breakout was more important from a fundamental standpoint than I expected.

Let’s look at the HDY daily chart real quick:

Screen shot 2014-05-12 at 12.57.25 PM

Notice anything that seems important? How about the huge drop on March 12, 2014? There’s also the huge breakout on May 5, 2014. Could the two be related? Well, obviously that is my point.

On March 12, 2014, a press release titled “Tullow declares force majeure on Guinea project after partner probe” was released.

On May 5, 2014, a press release titled “Hyperdynamics Announces Lifting of Declaration of Force Majeure by Tullow” was released.

Now, if you were new to this stock, as I was, this news may not seem like a big deal. After all, I barely remembered what a Force Majeure was from my previous law classes so I did not expect the stock to run. Doing some basic research on the history of the stock would have told you that this was a huge event. The story on May 5, 2014 practically filled the entire gap caused from the gap down on March 12, 2014. This movement makes sense, however, HDY jumped almost 200% on May 5, 2014 so the move didn’t seem very sustainable.

So, How do you incorporate this into your trading strategy?

Always take a holistic approach to your trading. Take all factors into account. Think about who is currently invested in the stock, who has the stock on their watchlist, what major catalysts can move a stock, etc. Charts are useless if you do not use them to tell a story. Try to think about a stock like a real business. If you were buying a real business, you would want to know all of the details. If the business’s value dropped considerably at one point, you would want to know why. You would also want to know who the customers of the business are (shareholders for this analogy). You would want to know about all current issues the business faces.

Don’t get me wrong, the majority of the time I trade, I don’t do this. I make trades off of the charts and don’t think twice about what a company does. That being said, I try to make my strategy as holistic as possible. When I see a big mover that is worth my time, I do fundamental research. You can never know too much about the stock. This is a whole different strategy from technical trading. I don’t only trade technical setups. In fact, some of my most profitable trades have been from learning a company’s story and placing trades accordingly. Keep in mind that knowing a story is different then believing a story. You want to know the story so you can understand how other traders are thinking. You do not want to believe the story as you will fall victim to the same thought process of the majority of investors, which can cause you to lose your competitive edge.

As always, do not take my trading tips as concrete strategies that should be implemented into every trade. Use these tips as tools and use them when they are necessary. I use different strategies for different trades, however, I like having a full toolkit at all times.

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