There are quite a few emotions involved in trading. While I’m a strong advocate of emotionless trading, I still believe it is important to understand the emotions of the market. This is what gives you an edge over other traders.
One of the strongest emotions that most traders deal with at one point or another is panic. People may experience panic in different ways including stress, fear, and anxiety. If you want to be an emotionless trader, you need to control your panic. That being said, if you ever feel panic while trading, it is not necessarily a bad thing. This can allow you to understand how everyone else may feel at a given time, which allows you to get into the minds of other traders. The key here is to not let panic influence your trading. When you are trading under the influence of panic, you are not making wise decisions. You begin thinking of the worst case scenario and making it a reality in your head. This should be avoided at all costs.
Here are a few ways to avoid feeling panicked when trading:
Have a plan and know your risk – If you have a plan when trading a stock, there is no reason to feel panicked. Having a plan means understanding your risk when you enter a stock and being prepared to accept that risk if things don’t go as planned. You can determine your risk level based on your personal risk tolerance, support levels, or a maximum dollar loss. For example, if you enter a trade and decide that you don’t want to lose more than $100, you should sell your shares when you are down $100; it’s that simple. You were prepared to lose $100 and you lost $100, meaning there is no reason to panic. Of course, you need to make sure you choose a risk level that you are truly okay with. If $100 will hurt your account, set a $50 risk level, or whatever works for you. Some people struggle with accepting the losses. “Well, I’m down $100, but what if it bounces soon?” Unless you are 100% confident that the stock will bounce, you should ignore “What if?” statements. You won’t get every trade right, but that’s just part of the game. If you ignore your plan, you have no rules to guide you and panic can take its toll. You may miss out on some gains, but you will also protect yourself from losses that you are uncomfortable with. This leads to my next point
Use proper size – When you enter a trade, you need to be using the proper position size that allows you to play the stock properly. I’ve heard the phrase “If you’re worried, you’re in too big” thrown around. If you have a mental risk tolerance of $100 per trade, find your risk level, and choose your position size accordingly. If a stock has $0.10 of risk, you can buy 1000 shares. If a stock has $0.20 of risk, you can buy 500 shares. I learned this lesson the hard way a few times while trading sub-penny stocks. I would take huge position sizes because I was focused on the potential reward. When the stock would start dropping, or simply fluctuating within it’s range, I would get worried because I was in too big. This would cause me to sell minimize profits, take losses, average down, or make other poor trading decisions. Some sub-penny stocks may need to drop 20-30% before running up 50%+. If you panic when the stock drops 20% and sell your shares, you will miss out on the future gains. While you may not be comfortable losing 20% of a $10,000 position, you may be able to stomach losing 20% of a $1000 position. Once I started taking smaller positions, I started trading better. I would assess my risk and choose a position size accordingly. I wouldn’t panic when everyone else was selling because I knew my risk and I was comfortable with it. Considering there is so much uncertainty in the markets, smaller gains and smaller losses are better than bigger gains and bigger losses. If you take too many big losses, it can mess with your confidence and may even prevent you from being able to trade. When choosing a position size, focus on your risk and not the potential reward.
Don’t listen to other people – When you are down on your position, you may get curious about how other traders are handling the situation. You may check message boards or Twitter to see what people are saying about the stock. This is a good part of being a diligent trader, however, you shouldn’t believe everything you read. Not all traders know what they are doing, and the internet allows people to hide behind their shields of anonymity. It’s okay to listen to people who you know are credible, but you should ignore the others. Some people like to prey on panicked traders because they are short the stock or want to buy shares for cheaper. You don’t know people’s motives and you don’t know their trading abilities, so don’t let them influence you. People tend to panic when a stock is dropping. You do not want to get consumed by the panic of others. Panic can spread like the plague. If you can’t stomach hearing what others have to say, just avoid listening to them. Of course, this recommendation is contingent on the fact that you had a well formulated plan based on your risk tolerance (as discussed above).
Use your panic to understand others – All traders have been worried about a trade before and this panic can influence stock prices because traders will buy and sell accordingly. It’s okay to be worried as long as you are conscious of the fact that you may not be able to make the best decisions. When I feel worried about a trade, I like to use that emotion to understand how others are feeling. I combine this with my level 2 analysis and other tools. For example, assume a stock is dropping and you expect it to bounce. Bid support is dwindling and sell orders are being stacked on the ask. The stock keeps dropping and you are tempted to sell it to cut losses even though you are confident that it will bounce higher in the coming days. Understand that your desire to cut losses is triggered by panic and many other people are feeling the same way. This means there will be a strong sell off triggered solely by panic. Keep in mind, there are also traders who do not have positions in the stock that are waiting to buy in at these lower prices. When the panic fades and new investors have purchased cheaper shares, the stock will have room to run. If you sell into the panic, you may find that you sell your shares at the bottom. Understanding how panic trading works gives you an edge over other investors. When everyone else is blinded by their emotions, you can think clearly and hold or buy shares accordingly. This doesn’t mean that you should buy into or hold onto a losing play. It means that you should focus on why a stock is dropping. If the drop seems random, or like a “chain reaction”, and there is no known catalyst, you can assume panic may be present. Assessing whether a stock is dropping due to panic is not easy. I use level 2 as my basis for this and I only apply this strategy to lower volume penny stocks because there are less orders to analyze.
Towards the end of last week, I was trading a company called NWGC. I liked the company from a fundamental perspective and they had just run up from a pump so there were a lot of eyes on the stock. Normally, I don’t like buying into pumps this late, but I was not buying the stock because it was a pump. I was buying it because I liked the company and figured the pump may have been helpful in attracting some fundamental traders. That being said, I knew it was a pump so I waited for the stock to pull back a bit. I wanted to get shares under $0.01/share so I waited patiently. As it started to dip below $0.01 I decided to load some shares. I started loading shares at .0095/share while flipping some along the way to take advantage of spikes so I could buy cheaper shares later. I was actually looking forward to every price drop so I could get more shares. Based on my fundamental analysis, the company was extremely undervalued. Plus, I thought it would eventually bounce of one of the support levels. Eventually, the stock pulled all the way down to .0052/share and I was down a good amount on my investment. Luckily I was locking in profits on the spikes, or I would have been down a lot more.
Anyway, as the stock was dropping you could tell that people were panicking. I had a plan and I knew my risk (Rule #1) . Unfortunately support levels were being taken down too fast for me to exit my position where I had planned so I was stuck holding too many shares. However, I liked the company, and I knew they were worth more money based on my fundamental analysis. It’s not like the company’s fundamentals were changing as the stock price was dropping. There was no dilution or negative catalyst present, so there was no real reason for the drop, other than traders getting bored (or, of course, panic). Since I got into this stock because it was undervalued, I decided to not worry so much about these drops. Unfortunately, I ignored Rule #2 so I was entering positions that exposed me to too much risk. I was able to minimize losses by analyzing the level 2 screen for good entry and exit opportunities, but, I was still in too big. The selling continued and the stock kept dropping Wednesday through Friday. By the time the stock was in the .0055 range on Friday, I was down about 25% on my investment, which was substantial considering the size of the position. I had to make the difficult decision of whether or not to cut losses and move on, or hope for a bounce. I checked the stock message boards and Twitter to see how other traders were reacting. I noticed there was a lot of negativity and fear. The crowd that was praising the company during the run was now panicked and forgot why they invested in the first place. Each time another sell order went through, more traders were tempted to unload their positions before it was too late. I wasn’t going to fall victim to this trend (Rule #3). I realized 2 important things.
First of all, the 50-Day simple moving average was at .0042. This should act as support if all else fails. Of course, it could break, but I was already down a lot so I didn’t mind waiting to see if it held. Plus, the risk/reward ratio was better at these levels. I reanalyzed the trade and set a new risk level (Rule #1). I sized out a bit and unloaded some shares at break even just in case the stock dropped further (Rule #2). I ignored the negativity on the message boards and even added some optimistic insight (Rule #3). And most importantly, I thought about how I was feeling and applied it to how other traders may be feeling (Rule #4). I noticed that every time there was a big order on the bid after support broke, I was tempted to sell and move on, but every time someone took out shares on the ask, I became bullish again. This made me realize that all this stock needed was a little bit of buying pressure for it to see a nice bounce. The ask side of the level 2 screen was thin; there just wasn’t any buying pressure quite yet. Once a bottom had formed, this would have more room to run. So, after reformulating my plan, I decided to hold my shares and hope for the best. As you can see from the charts below, NWGC opened up at .0055 on Monday, got some buying pressure and ran up over 60% during the day. I didn’t time my exit perfectly, but I saved a hell of a lot of money by not selling into the panic.
Seeing the Panic in the Charts
In my opinion, it is easier to see panic on a level 2 screen, but I do not have that available so I will use the charts below.
Look at the 10-minute chart for NWGC below (The highlights are not exact, but you should get the main idea). Notice that the stock would run, then consolidate, then repeat. This went on for a few days until eventually the stock hit a top. There were some big drops, but the stock held above .01/share for a good amount of time. Even during the pullbacks and consolidation, the overall trend was still bullish. When it broke the .01 level and couldn’t move back above it, the panic started to set in. Suddenly this was a sub-penny stock again and people’s perspectives changed. Previously, there were huge dips and huge spikes as the bulls and the bears battled it out. After the drop below .01/share there were no big spikes, however, there were a few big dips. The spikes would need to return to support a bullish sentiment.
NWGC – 10-Minute Chart (Click to Enlarge)
Now look at the 5-minute chart below for the time period of the panic. Notice how support levels were being taken out again and again. Each time a support level was broken, the stock would plummet and “consolidate” at the next support level until there were almost no support levels left. The chart was now clearly bearish, so even the bulls were in a panic. As of June 12, the stock could no longer move above .01/share. The trades were more scattered throughout the day because there was uncertainty in the markets. Buyers didn’t want to load up on shares because the stock was bearish and sellers were still hoping for a bounce. There was a lot of uncertainty. When the stock would dip, the uncertainty translated to bearish sentiment and even more people unloaded shares, triggering a chain reaction. This uncertainty was both good and bad. It meant that if the stock dropped more, people would be bearish. It also meant that if the stock showed signs of strength, people would be bullish. As you can see, on Monday, the stock started off bullish and continued the trend for almost the entire day.
NWGC – 5-Minute Chart (Click to enlarge)
Last but not least, let’s take a quick look at the daily chart. Notice the area where the panic started to sink in. It started June 11 (the first red candle in the red panic box) as the last few minutes of the trading (as seen on the 5-minute chart above) day sent the stock plummeting, creating a big red candle. Until then, the daily chart looked like it could be consolidating above .01/share and preparing for another run. That big red candle made the daily chart look bearish, which triggered panic.
NWGC – Daily Chart (Click to enlarge)
How the Stock Ran (Relative to Panic)
Of course, there are many reasons, but let’s focus on things from the perspective of panic for the sake of the article. I already talked about how there was a lot of uncertainty and any bullish signal could push this up fast, but there is another important principle involved. During this whole time period (the red box), the panic was actually being filtered out of the stock. Buyers who bought during the peak of the run were selling for losses, meaning they no longer had a stake in the company and could no longer be panicked. Every time someone sold out of panic, their panic was removed from the market and their shares were transferred to someone who had a better entry point. For example, someone who bought shares at .016/share during the run may have sold his shares to someone at .006/share during the drop. Now, when the stock drops to .0055, there is less panic in the midst. The guy who bought shares at .016 would have a 65% loss when the stock price dropped to .0055/share. That is a recipe for panic. Someone with a loss that large could sell into the bid or put up a wall on the ask at anytime, which continues the downward trend. Meanwhile, the guy who bought shares at .006/share would only have an 8% loss when the stock dipped to .0055, which is not too bad for a volatile stock like this. This guy has no reason to sell the shares on the bid or put up a wall on the ask because his loss is minimal. Essentially, shares were exchanging hands from panicked investors who didn’t time their entries properly to traders who bought on the drop and had less fear of downside due to their better entry price. Of course, there were still people who held despite their large losses, and their risk tolerance would be tested every time the stock dropped further. That being said, at a macro level, panicked traders with massive losses were being replaced by traders who had less to worry about. Of course, the stock could keep dropping, but it’s important to remember that this company had good fundamentals and active pumpers. If it dropped too low, traders would jump on the chance to get cheap shares, which would provide the bullish signal this stock needed in order to bounce.
How to Use all of This
Understanding panic in the stock market should just be another tool for you to use when you are trading. You don’t want to place trades solely based around the principles discussed above, however, you can incorporate these principles into your current trading strategy. Obviously, NWGC’s price action in the example above was not solely driven by panic, however, it definitely played a role. Understanding panic in the stock market means that you understand another element of the market environment, which gives you an edge over other traders. Level 2 is the best tool to use for analyzing panic. Pay attention to the different orders that go through and think about their significance. Sometimes a stock may be dropping because of dilution, in which case you shouldn’t expect the same bounce as you would if a stock were dropping mainly because of panic. By analyzing level 2 trends you can pinpoint the reason for a drop. Not all drops are caused by panic, but all drops do cause panic. Be conscious of your own panic and the panic of others and you can learn how to place trades without emotion. The end goal should be to eliminate panic from your own trading while taking advantage of the panic of the market.
If you have been trading penny stocks for awhile now, you probably visit some message boards. My “go-to” board is Investors Hub because it is one of the biggest boards for microcap stocks. While these boards can be a helpful part of your trading strategy, they can also be detrimental to your success if you do not know how to analyze the information available. Some people will tell you to just ignore message board banter, but I disagree. I think it is important to analyze the discussions because it gives you some insight into market sentiment, which I discuss in this post.
I am going to go over some things to look out for with these message boards, as well as some of the different characters you will see on these boards.
Meet the Gang
This isn’t everyone, but it’s a lot of the main players. (Yes, I am using animated characters)
The “Hype” Guy
Why they’re good: They can help support a run on the way up and get others enthusiastic about a company. Essentially, these guys are marketers that help market the stock.
Why they’re bad: They run out of credibility very fast by continuously pumping different stocks. Their job is to hype companies and they ignore price action. A lot of the times the hype is not based off of anything substantial.
What to look out for: It’s nice to see hype guys on a board for a stock you own. Essentially, you have someone marketing your stock for you, which may lead to higher gains. Just remember to never actually listen to anything these guys say. They have their heads in the clouds. Do your own research but know that the hype guys can help support a positive sentiment towards a stock.
“Blue sky breakout coming!”
“Shorts will be sorry soon”
“Gathering cheapies today”
“Know what you own”
“Holding long and strong!”
Why they’re good: Bashers can balance out the hype guys. Sometimes, bashers are realists that can negate the wild fantasies of the hype guys. Additionally, the bashers can sometimes scare people into selling their shares, which can drive the price of a stock down, allowing you to buy cheaper shares.
Why they’re bad: Most bashers are not trying to help anyone; they are trying to see the stock price drop. A lot of their claims are unsubstantiated and they can panic investors. Having bashers in a stock you’re involved in can make it difficult for the stock to run at certain times.
What to look out for: Look for how many bashers are involved in a stock to see if they are the minority or majority. You should be cautious when there are more bashers because they can create a negative market sentiment that may lead people to sell their shares in fear.
“(Insert super low price target) coming soon!”
“SEC Suspension coming soon”
“Scumbag CEO fooled you all”
The Technical Analyst
Why they’re good: They can add some decent insight to the boards every now and then. This insight can be used to time entries and exits, however, you should not be looking to others for help with that.
Why they’re bad: Most technical indicators do not really matter for low volume penny stocks. Most people use reverse logic to prove their point. If someone wants the stock to run, they will look for indicators that support their theory.
What to look out for: Do not listen to a thing they say. Technical analysis is already tricky for penny stocks. Don’t listen to someone who has absolutely no credibility. If you want to use technical analysis, develop your own system. These guys are wrong about their analyses more often then not.
“RSI is about to enter power zone”
“Chart is primed for a run”
“Perfect fibonacci retracement, gearing for a major run!”
The High Roller
Why they’re good: High rollers can get a good crowd involved with the stock. Real “high rollers” will bring a lot of capital into a stock, which should be reflected in the stock’s volume.
Why they’re bad: Most high rollers are not actually high rollers. You don’t know anything about them or their lifestyle. Often times, these guys like to trade in groups (similar to pumpers), which means there is front loading and many people will get burned when the run is over.
What to look out for: Check a person’s reputation. See how their last couple of picks played out and analyze the validity of their previous claims. If you follow these guys, which I do not recommend, you want to make sure you time your entries and exits precisely.
“Big money coming into (Insert Stock Here)”
“Multi-bagger in the making”
“Still holding every single share. Huge things are coming!”
The New Guy
Why they’re good: New guys can sometimes be led to invest in anything. They buy into the hype from the hype guys which can help support a run. We’ve all been here before.
Why they’re bad: Newbies often waste space on boards by posting meaningless content. They may also believe that they are more experienced than they actually are. This makes it harder to properly analyze message board posts.
What to look for: Look for people who are exceptionally emotional. These are the new guys. Be aware of the fact that their posts have little validity. This isn’t meant to be rude; we’ve all been here before. You don’t really need to look out for newbies as they don’t affect the trading too much, however, it is important to know when someone is a newbie so you can understand where they are coming from.
“What stock should I buy today?”
“This is crazy! Why is this stock dropping?”
The Rare Unbiased Analyzer
Why they’re good: First of all, an unbiased poster is extremely rare. These people are good because they create real discussion about a stock. They analyze both the positives and negatives and give weight to both. These traders can help you think about stocks from a rational, emotionless perspective.
Why they’re bad: Sometimes being unbiased means sharing negative facts about a company. This can lead to a strong negative market sentiment because the posts are valid and cause concerns.
What to look for: Make sure someone is really unbiased. Look over their previous posts and see what they have said in the past. Also, keep in mind that a rational analysis does not guarantee that a stock will behave in a certain way. Just because someone is unbiased doesn’t mean that they are right. Use these posters to understand a company better and to improve your own due diligence process.
“The P/E ratio values this company at (insert number here)”
“Let the market decide”
What to Look Out For
The Power of Posts – It almost seems a bit silly to do an entire post about message boards on a site about trading/investing. Do the message boards really matter? In my opinion, yes. Message boards can be extremely powerful because they can influence people’s trading/investing styles. Think about it, if you go to a board with nothing but positive comments, wouldn’t you be slightly more inclined to invest than if you went to a board with nothing but negativity? I’m not saying to make trades solely off of message board posts; that would be stupid. I’m saying you should use message boards to help gauge the market sentiment surrounding a stock. It’s a great tool. What better way to get into the minds of other traders? You will also want to keep in mind that everything posted carries some power. If you post something negative, you risk driving the price down. No, there is not a direct correlation, but you have to understand the power of your words. If you say something that deters one investor, that could have an effect on the stock. For example, whining about a company that you currently have losses on is foolish because you may scare away other investors. A lot of penny stocks have extremely low volume, meaning that there are few traders involved. While message boards won’t affect the prices of big board stocks, they can certainly influence the prices of low volume penny stocks.
Ulterior Motives – Anytime anyone posts anything on any board, they have some sort of motive. Sometimes, these motives can be as innocent as enjoying a conversation with other investors or making the trading day more interactive. More often than not though, people have an ulterior motive. If they want to see a stock price go up, they start talking positively about a company, and if they want the price to go down, they start talking negatively. Be careful when trying to make sense of all of this and think about why someone would post something. Remember, posting takes time and time is valuable. People need to have a reason to post. No one is out there trying to make you money. They are trying to make money for themselves. Keep that in mind and ask yourself why some people post what they do.
The Credibility of a Poster – The great thing about message boards is that all previous posts are easily accessible. If you are even thinking about listening to something someone says, you will want to make sure they are credible. Look at their previous posts and compare them to present results. If someone was hyping a stock and it dropped considerably, they are no longer credible to me. Similar to how historical data on stock charts can help show the future, historical posts from message board users can do the same.
Price predictions – Never listen to a price prediction: simple as that. No one has any real way of knowing how high or low a stock will go. Even when I am bullish on a stock, I don’t make price predictions because they would be unsubstantiated. Only the market can decide how high or low a stock goes.
Doomsday Predictions – People love to spread panic on days when traders are already panicked. When a stock is down, people will begin talking negatively about a company, making investors wonder why they invested in the first place. Feel free to analyze these predictions, but know that most of them are just made by bashers who are kicking investors while they’re down. They want to drive the price down because they are short the stock or want to buy in lower. These doomsday predictions will disappear the second the stock shows any sign of strength.
Fairweather Traders/Hindsight Analyses – This is a HUGE aspect of message boards that can be taken advantage of. People tend to change their opinions on a stock relative to its price action. If a stock is up, everyone is enthusiastic about its future. If the stock is down, everyone starts making doomsday predictions and finding all of the negatives about a company. Don’t get sucked into this emotional whirlpool. Be the person who can keep their eye on the prize. If you invested in a stock, you should have a good reasoning behind it. Don’t let that rationale falter when the stock drops in price. Of course, you should react accordingly, but don’t change your entire view on a company. The people panicking during the drop will be the ones rejoicing during the spike.
Reverse Logic/Technical Analyses – A lot of people make up their mind about a stock and begin finding evidence to support their opinion. This is the exact opposite of what the due diligence process entails. Watch out for posters who have a strong, biased opinion and will use any information to support it. People will use anything from technical indicators to fundamentals to prove why they made the right choice. You should be looking for ideas that challenge your own, not blindly falling in love with a company.
Fundamental Valuations – There are a lot of fundamental valuations posted on message boards, some more substantiated than others. I’ll admit that I do fundamental analyses during my due diligence process, however, I never accept the findings as concrete proof that a stock will run. The market can easily ignore fundamental analyses, and it will for a majority of stocks. After all, most penny stocks should be worth $0. Use fundamental analyses as a fallback to a more solid trading plan and ignore hyped up analyses by others.
Conspiracy Theories – These are my favorites. When a stock is doing really well or really poorly, people start trying to make something out of nothing. They will go to great lengths to talk about potential deals a company could have, or potential reasons for their demise. “Just wait and see, this company will announce a deal with Apple soon.” No, they won’t. If something seems too good to be true, it is. Unless something is backed up by solid facts, it is garbage. Don’t invest based on “maybes.” Invest based on cold hard facts.
CEO Hate/Love – This is one of the most ridiculous ones I see. I even did a post on it. People love to act like they know a CEO personally. They think the CEO is watching out for them or that the CEO is pure evil. Don’t listen to either of these. The fact remains that you don’t know the CEO personally. They may be a great person, or they may be a great con man. Additionally, a lot of things may happen that a CEO has no control over. Once again, focus on the facts and ignore anything that may seem unsubstantiated.
In any business situation, you will want to be fully conscious of your environment. Your “environment” encompasses so many things, however, one of the most important is people. Knowing about the people you are dealing with gives you a competitive edge in any business situation. The stock market is no different. This is a huge part of trading psychology that you should be aware of when considering entries and exits. I decided to write this article because I find myself facing this issue whenever I test out new strategies. It is easy to forget that not all traders think the same. Yeah, you probably knew that, but have you really incorporated that knowledge into your trading strategy?
Far too often I see people getting angry at other traders, critiquing trading styles, and failing to understand why stocks are behaving the way they are. “Why the hell is everyone selling when there is big news expected at the end of the month?!?!?!” Simple, because some traders don’t want to hold shares for a month. It is important to remember that all traders are trying to make money. Anyone who is making money consistently has a solid strategy. That being said, not all of these strategies are the same and people like to stick to what they know. Sure, day traders may be able to make a lot more money in certain cases if they hold a stock for longer, but that is not their style so don’t expect them to become an investor overnight. Don’t get angry about other people’s styles and opinions. Learn from them and take advantage of them. This is why it is so important to remain emotionless while trading. You can just sit back and analyze the situation free from any biases. Let’s take a deeper look at why it is so important to understand other people’s trading styles.
Why does it matter?
You probably already knew that everyone has a different trading style, but whyexactly is this so important? Why should you care about how someone else trades? The answer is simple. People’s trading strategies affect their entries and exits. Entries and exits are buy and sell orders that affect stock price movement. Therefore, different trading strategies are responsible for the price movement you see every day. It doesn’t matter if you agree with someone else’s trading strategy or believe in its feasibility. What matters is that the person using the strategy believes in it and that belief will be reflected in the stock’s price action. Understanding how different traders are playing a stock will give you an edge. Let me give some examples:
Charting Example – I am neither a strict chart trader nor a strict fundamental trader. I use a variety of strategies when I trade and don’t overvalue any of them. That being said, some people have a method that works and they stick to it. I always have to remind myself that some people use stock charts religiously. When a stock is approaching a known support level during a down trend, there will be a lot of chart traders looking to move in for a dip buy. Maybe it is a self-fulfilling prophecy, but that doesn’t matter. All that matters is that you know what these traders are doing and act accordingly. If you know a stock will have heavy buying at support, you may consider an entry for a bounce. The same applies to resistance levels and technical indicators. It doesn’t matter if you believe in chart trading. What matters is that other people do and this will affect the price. Sometimes, I can be slightly cynical and expect the worst when a stock is moving towards its support levels. Are people really going to buy at that price when the stock is tanking? The answer is “yes” and when enough people do it, a trend is formed.
Penny Stock “Investors” – I would never consider a purchase of shares in a penny stock company a real “investment.” There is too much volatility, shadiness, and other random factors that make the investment risky. That being said, there are a lot of people who actually invest in penny stock companies. When I find companies with a strong, almost “cult-like” following, I take advantage of this. These investors lock up the float and provide support during big drops because they see the new share prices as a great value. Does this mean I am going to invest in the company? No. It means that I understand how other traders are thinking when they place trades, and that helps me plan my entries and exits.
So, let’s get straight to the point and go over some different trading styles that you should be aware of.
Popular Trading Styles
I will go over a few popular trading styles below. Some of them overlap, but try to focus on the psychology behind each style. Think like a person utilizing the strategy would think.
Day trader/scalper. The numbers are not exact and each trader within the subcategories will be slightly different. Just use this chart to understand the bigger picture.
Based on price action
Chart Patterns (Intraday + Daily)
Price Action (Level 2)
Responsible for a lot of volume
Don’t hold positions over night
Don’t usually care about company fundamentals
Don’t care about long term potential
Can push a stock price up and down fast.
Won’t lock up the float
Has a strategic plan
Out of a trade fast if it doesn’t go as planned
Utilize stock screeners
Based on price action
Chart Patterns (Daily)
Price Action (Level 2)
Value company fundamentals sometimes
Use charts for price targets
Buy around support or broken resistance
Not real “longs” but similar traits
Will sell when price target is reached
Looking for higher gains than day traders
Based on safe, easy trades
Price action (Level 2)
Don’t care about fundamentals
Try to make a lot of small gains
Needs to trade high volume to make good profits
Place safe, easy trades to take advantage of predictable price movement
Utilize charts for planning entries and exits
Help sustain volume in a stock
Can make it harder for a stock to run
Based on price action
Chart patterns (Intraday)
Look for volume and hype
Value charts over fundamentals
Take advantage of catalysts like news
In and out of a stock fast
Utilize stock screeners
Sub-category of day trading
Varies by trader
Chart Patterns (Intraday, daily, weekly)
They add validity to chart patterns
They are predictable because you can look at historical data
Use a variety of complex technical indicators
Can help support breakouts on multiple time frame charts
Very methodical/strategic traders
Based on growth prospect
Varies depending on news
Contribute to momentum
Push the price up or down on news
Can be day traders or swing traders
Predictable because news is their trigger
Price targets vary by price action depending on how traders interpret news
Varies by trade
Chart patterns (intraday + daily)
They sell shares and want to push the price down
They are betting against a company’s success
Their are certain regulations they have to follow (important to know)
Usually very cynical of many companies
They can get “squeezed” and cause a stock to breakout
Based on hype
Trying to get rich quick
Message board banter
“Bagholders” lock up the float
Naive and not strategic
Usually has less capital
Buys into hype and regurgitates it
Does not understand risk management
Driven by greed
Lacks feasible price targets
Doesn’t have strong rationale behind a trade
Usually very active on message boards
Lock up the float
Varies based on fair value
Sell when fairly valued
Accounting ratios + formulas
Focuses on what a company does and how well they do it
Looks for undervalued companies
Truly believes in company so holds shares longer
Has realistic price targets based on fundamentals
Doesn’t give too much weight to charts
Ignores intraday trading patterns
Can forget that a stock’s value is determined by the market
Can become a bagholder
Lock up the float
Varies by company
Sell when company peaks
Accounting ratios + formulas
Looks for growing companies
Similar to value investors but puts more weight on future performance
Often invests in booming sectors (eg. Marijuana)
Values a company’s fundamentals, specifically their growth rate
Doesn’t give too much weight to charts, but prefers upward trends to confirm fundamental research
Focuses on long term price action not intra-day moves
Does a lot of due diligence on a company
Lock up the float
Buys into hype
Sells when hype is gone
Message board banter
Invests based on hype (eg. marijuana)
A more refined version of “Gamblers/Dreamers”
Different from momentum traders
Uses social proof so easily influenced
Has minimal rationale behind trades/investments
Sees what they want to see
Usually doesn’t have a risk management plan
Usually very active on message boards
Lock up the float
What does this all mean?
Now, you have some data about some different kinds of traders and investors. This data is useless unless you find a way to incorporate it into your strategy. The best way to do this is to be conscious of other people’s trading styles and find a way to take advantage of them. For example, you may not be a “News Trader” but if you know there are people playing the news, you can get in on that trade and make a nice profit. You may be a “Value Investor” but your stock starts running up from momentum. You may want to take this time to sell some shares because you know some momentum traders will be selling soon. Knowing how other people trade can help make your strategy even more effective. This list only covers a few different types of traders and people can find themselves in more than one category. Think of some the other kinds of traders and put yourself in their shoes. Try to think like exactly like them so you can know their thought process and predict their future actions.
I started this article off with a reference to business and how important it is to understand the environment you compete in. If you run a business, you would want to know exactly what your competition is doing. You could replicate the positive things and avoid the negatives. Additionally, you could take advantage of your competition’s shortcomings. If you know your competitor is always closed on the weekends, you could run a marketing campaign telling people you stay open all week. The same logic applies to trading. Know other people’s trading styles, learn from their strengths, and take advantage of the insight you gain. If you know that everyone is going to run a stock up in a week on earnings, give yourself an edge and buy early. There are no definitive rules about how you should take advantage of other people’s trading styles. Get creative and start testing out strategies.
For the longest time, I was focused solely on the percentage gains of any trade. I would look at a stock price and determine how much it would need to run for me to get my desired percentage gain. Usually, I would look for gains of at least 10%, so if a stock was at $8/share, I would want to make $0.80/share, and if it were at $2/share, I would want to make $0.20/share. If I didn’t think a stock could run at least 10%, I would avoid it. After all, high percentage gains are one of the main reasons I love penny stocks. That being said, I don’t only invest in penny stocks, so I account for other scenarios so I don’t miss out on easy trades.
Recently, I have changed my strategy for one main reason; I rarely use all of my cash in one trading day. Percentage gains really do not matter too much if you are not leveraging all of your cash. Additionally, I set my risk exposure based on dollar amounts and not percentage amounts. If my risk exposure for each trade is $200 (it varies for me), that remains constant, and I don’t care if I invest $1000, $2000, or $10,000 on the trade.
This post is not about some revolutionary new trading strategy, but simply a different perspective that may open the doors to more possible trades.
Think about this:
For this example, assume both stocks mentioned below have the same dollar risk/reward ratio of 1:1 with a potential risk of ($0.20)/share and a reward of $0.20/share. Here is how this trade would work when things go as planned.
Scenario A1: You buy 1000 shares of a stock at $8 and it runs to $8.20 where you sell it. You made $200 on an $8000 investment.
Scenario B1: You buy 1000 shares of a stock at $2 and it runs to $2.20 where you sell it. You made $200 on a $2000 investment.
Scenario A yields a 2.5% gain while Scenario B yields a 10% gain. Scenario B is clearly a better trade, BUT they both yield the same return of $200.
Both trades have their advantages and disadvantages. The obvious argument here is that you should compare both trades using the same initial investment.
Sure, let’s do that.
Scenario A2: You buy 1000 shares of a stock at $8 and it runs to $8.20 where you sell it. You made $200 on an $8000 investment.
Scenario B2: You buy 4000 shares of a stock at $2 and it runs to $2.20 where you sell it. You made $800 on a $8000 investment.
Scenario B is looking a lot better now right? Well, yes and no. You forgot that the trade can also go against you. Scenario B may expose you to more risk than Scenario A. Of course, every trade will be different, and it is important to assess risk levels before entering a trade. However, as mentioned above, these stocks have a risk of ($0.20)/share as well.
So, how would the trade work out if it went against you?
Scenario A3: You buy 1000 shares of a stock at $8 and it drops to $7.80 where you sell it. You lost $200 on an $8000 investment.
Scenario B3: You buy 4000 shares of a stock at $2 and it runs to $1.80 where you sell it. You lost $800 on a $8000 investment.
As we saw above, your gains were increased by using the same initial investment on both trades, however, so were your losses. If your maximum risk exposure was $200/trade, you could have never placed the trade in Scenario B because it exposes you to $800 of risk.
What’s the point of all of this?
In no way am I saying that the trade in Scenario B2 is a bad move. I’m just trying to shine light on the fact that percentage gains should not be your only focus. Imagine that one investor takes their portfolio from $1000 to $2000 by the end of the year, while another takes theirs from $20,000 to $25,000. The first investor enjoys an 100% portfolio gain, while the second enjoys a 25% portfolio gain for the year. At the end of the year, the second investor still made more money ($5000 vs. $1000) which is the real bottom line of investing.
Here’s a day trading example. Let’s say your average trade size is $10,000. If you make one trade in the day that yields 10%, you make $1000 for the day. 10% gains are harder to come by so you will be limited in the amount of trades you can find. If you make 10 trades that yield only 2.5% each on $10,000 investments, you can make $2500 for the day. Of course, stocks that run 2.5% intraday are much easier to find than stocks that run 10%.
What You Need to Account For:
1. How much free cash you have in your account – If you have a smaller account, you will want to focus on percentage gains because they will help you grow your portfolio faster. If you have a larger account and don’t use all of your cash every day, it would be wise to consider taking some smaller percentage gains to grow your account. This will be better than just letting your cash sit, especially if you can find low risk trades.
2. Pattern Day Trader Rule – Accounts with less than $25,000 are limited to a maximum of 3 round trips per week (round trip = buying and selling the same security during the same a day) based on SEC guidelines. If you can only make 3 round trips a week, you will want to make them count. You should be focusing on percentage gains because you are limited in the amount of trades you can make.
3. The Time Value of Money – This article is targeted towards day traders who buy and sell stocks within the same day. If you are holding a stock for more than a day, percentage gains are more important because your money is tied up until you sell the particular security.
4. The Dollar Risk/Reward Ratio for a Trade and Your Risk Exposure– This is by far the most important thing to account for. In the above examples (Scenarios A & B), there was an assumption that both trades had the same risk/reward ratio from a dollar gain/loss stance. This will not always be the case. When trading stocks with lower percentage gains, you also want lower risk. This allows you to leverage a higher percentage of your portfolio for the trade. So, in my fictional examples above, both stocks had a risk of ($0.20) and a potential reward of $0.20 (a 1:1 risk/reward ratio). Assuming the amount of shares you bought and the risk/reward ratio were constant, and the price per share varied, this made it so it didn’t matter whether you were investing $2000, $5000, or $10,000 because your risk was always $200 for the trade ($0.20 risk * 1000 shares). The percentage of my portfolio that I invest in a trade is relative to the dollar gain/loss per share, not the percentage gain. This leads to the next important reason why the risk/reward ratio is critical when focusing on percentage gains vs. dollar gains. Let me run through one more quick scenario:
Scenario A: Your portfolio has $50,000 in it. Your maximum risk exposure is $500 per trade. You find a stock trading at $10. The stock has a risk of ($0.10)/share due to a strong support level, and a potential gain of $0.30/share from an intraday bounce. The potential percentage gain is only 3%, yet the potential risk is only 1% for a 1:3 risk/reward ratio. This allows you to leverage a much larger percentage of your portfolio in the trade. In fact, based on your set risk exposure, you could even leverage your entire portfolio (you should never invest your entire portfolio in a trade, but this is a theoretical example). You can now purchase 5000 shares of the stock at $10, for a maximum loss of $500 (your set risk exposure) and a maximum gain of $1500. This fictional stock only has to run 3% for you to make $1500.
Scenario B: Your portfolio has $50,000 in it and your maximum risk exposure is $500 per trade (Kept constant throughout both scenarios). You find a stock trading at $1/share. The stock has a risk of ($0.25) based on a strong support level and a potential gain of $0.50/share due to a positive press release. The potential gain is 50% and the potential loss is 25% for a 1:2 risk/reward ratio. Based on your maximum risk exposure, you can buy 2000 shares at $1 (2000*$0.25/share risk = $500). If the trade goes in your favor, you make $1000. If it goes against you, you lose $500. This stock has to run up 50% for you to make $1000.
Scenario A yields a better dollar gain ($1500 vs. $1000) even though the percentage gain is 47% lower than Scenario B. Of course, you had to use more cash from your portfolio, but as mentioned in the first point on this list, if you have the free cash, you might as well use it. Keep in mind that understanding the real risk/reward levels is critical to the success of this tactic, and, you should always account for the fact that things may not go as planned. A stock’s price action doesn’t follow definitive rules and risk/reward levels may be breached at any time.
How to Use This in Your Trading
As mentioned at the beginning of the article, this is not some revolutionary new trading tactic. It is just a different way to look at day trades. I’m sure many traders already utilize this strategy. Apply this in a way that compliments your current trading style.
By no means do you want to turn this perspective into a strict trading rule. Both percentage gains and dollar gains matter at different times. Personally, I have used this strategy to shift my perspective on trading gains in a way that has opened the doors for more profitable trades. By recognizing that the bottom line of trading/investing is how much money you can bring in, you can look at certain trades in a new light. I look at each new trade based on how much money I think I can make while limiting the position size to account for my set dollar risk exposure. Some traders recommend choosing position sizes based on a percentage of your portfolio (eg: 10% of your portfolio used for each trade). That strategy is solid and helps minimize risk, but it can also limit your trading possibilities. I no longer care how much of my portfolio I leverage as long as I keep my risk exposure constant, nor do I care about my percentage gain on a trade as long as I achieve the dollar gain I desired.
One of the worst parts about investing in popular stocks such as large caps and small caps is that you are susceptible to market conditions. Over the past couple of days, the market has taken quite the beating and, consequently, many investors’ portfolios dropped significantly. Luckily, this drop did not affect my trading strategy. Of course, the title of this article is facetious, as I always pay attention to market conditions, however, it is intended to prove a bigger point. Certain markets function independently and are not prone to the influence of the larger markets. This is not to say that all penny stocks are uninfluenced by the larger markets, but there are a select few stocks that defy the macro sentiment of the large markets. Why is this? The answer is simple. Some stocks have a cult-like following that pays no attention to larger indices such as the Dow Jones Industrial Average, NASDAQ composite, and S&P 500. Essentially, these are micro-markets that follow their own set of rules. Stocks that fall under this category are traded way differently than main stream stocks. These stocks are not traded by wall street investors who pay attention to the overall condition of the market. They are traded by day traders, gamblers, dreamers, and others who are trying to make fast money (See my post about why “real” investors avoid penny stocks for more info).
So, what was I up to while the rest of the market was panicking about the massive drop? I was trading a company called Triton Distribution Systems (TTDZ). The company has positioned themselves in the medical marijuana industry and has mustered up a lot of hype. I was able to make a nice profit on the stock through intraday trades.
$528profitTTDZLong Stock Positive catalysts expected. Broke through long term resistance on Friday and spiked on monday.
TTDZ is the number one stock on Investors Hub – For those who don’t know, Investors Hub is one of the most popular message boards for discussing OTC stocks. Being a top stock on the site does not guarantee upward momentum, but it provides a crucial element for success: exposure. The TTDZ message board is read by tens of thousands of people. This leads to the stock gaining the exposure it needs to run, and the daily volume of nearly 120 million shares on Monday confirms this. There are many amazing companies that never reach their fair value due to a lack of exposure. Exposure can lead to high volume, and with positive catalysts in play, this can lead to a breakout.
Positive sentiment – I talk about market sentiment in another post and explain why it is so important. TTDZ had great positive sentiment from a cult-like following that believes the company is going to become a leader in the medical marijuana industry. A stock can run on positive sentiment alone, as proven by TTDZ. TTDZ had no direct catalyst that triggered its movement, but positive sentiment pushed the stock price to new highs. When you have tens of thousands of people reading a message board with mostly positive posts, this can influence new investors to buy shares and drive the price of the stock upwards.
The charts don’t lie – TTDZ was a great technical play based on the charts. The stock has been in an upward trend for weeks now. Volume sustains itself or increases alongside the share price, which is good, because dollar volume is increasing every day. Last but not least, the stock kept breaking through resistance levels without a problem. There were no “blue sky breakouts” after each break, but instead each new high was followed by a short run and consolidation. The stock continues to test new highs as I write this post.
Volatility and Liquidity – There were plenty of opportunities to buy and sell TTDZ. The stock would pull back to its lows intraday and set new highs intraday as well. My strategy consisted of buying shares at support levels and selling at resistance levels. The liquidity of this stock made this possible. With roughly 120 million shares traded, it was pretty easy to get buy and sell orders filled.
Positive catalysts expected – TTDZ shareholders are expecting a variety of positive catalysts in the near future, including financials, a ticker symbol change, and potential dividends. This anticipation builds a strong positive hype as investors believe the price will skyrocket in the future. Had a press release been disseminated the stock could have run even further, as it may do in the future.
Overall, TTDZ was an easy, predictable pick for making some fast profits. My percentage gain was not exceptional, but any gains are good gains. I limited my position size to avoid unnecessary risk. Notice how my rationale states nothing related to the company’s fundamentals. They did not matter in this case. So, what is the point here and why am I adding this example?
TTDZ traders did not care about the market conditions. No one was posting on message boards stating, “the stock is doing well, but the down market may takes its toll.” These traders do not care about the larger markets. As long as they are making money, they are happy. These aren’t wall street investors and they have a completely different mentality. It may seem naive to base trading decisions off of the posts on a message board, but when you think about the psychology of trading, it can make more sense. People are influenced by what they read, and their trades often reflect this. Of course, I had other reasons for entering the stock, as mentioned above.
A lot of other stocks on my watch list took a hit, but I avoided trading those stocks. The goal is to find stocks that fluctuate independently from the main markets on days when the market is down. By finding these stocks, you can protect yourself from drops in the market.
Making money in the stock market is all about being able to predict future trends. If you believe a stock price will go up, you go long (buy). If you believe a stock price will go down, you short the stock. The process is as simple as that, however, predicting price movements is not as easy as it sounds. If it were, everyone would make millions in the stock market. So, how does one predict the future price action of a stock? Chances are, if you asked 10 different investors you would get 10 different answers. Some will tell you to look at the company’s fundamentals and growth strategy. Others will tell you to do a sector analysis and make predictions accordingly. Some may even tell you to look at technical indicators such as the RSI, exponential moving averages, MACD, etc. So, who is right?
To put it simply, anyone who is making money is right. There is not one single way to be profitable in the stock market. Some people trade solely off of charts and make millions, while others trade solely off of company fundamentals and also make millions. Any strategy that makes money is a good strategy. That being said, I use somewhat of a unique strategy when I trade penny stocks. My strategy encompasses elements of all different strategies and aggregates them into a simple, easy-to use metric. I refer to this metric as “market sentiment.” This strategy is intended for penny stock markets, however, it could probably be applied to larger markets as well. So, what is market sentiment and why is it so important?
Market sentiment is very basic and very complex at the same time. Basically, market sentiment depicts how the majority of people feel about a certain stock at a given time. If the majority of people think the stock will go up, there is a strong positive market sentiment. If the majority of people think the stock will drop, then there is a negative market sentiment. Keep in mind that your opinions on the stock do not matter if they conflict with the majority of people. When people think a stock will go up (positive sentiment), they will put in a lot of buy orders. If people think the stock will go down (negative sentiment), they will put in a lot of sell orders. Essentially, this is somewhat of a self-fulfilling prophecy. The initial buy and sell orders on a given day can trigger even more buy or sell orders when people panic/rejoice at the price movement. By now, the concept should be clear. Positive sentiment drives the price up and negative sentiment drives the price down. This probably seems very obvious, so you should begin wondering how to gauge market sentiment.
First of all, gauging market sentiment is no easy task. In no way do I want to simplify the complexity behind trying to understand how an entire market feels about a stock. That being said, it is definitely doable, especially in penny stocks. Penny stocks are unique in the aspect that a lot of them are thinly traded (at least when compared to larger companies). This means that there is usually a small group of people trading the stock, which makes it easier to gauge the market sentiment. If a stock valued at a few cents trades 20 million shares a day, this means that 200 traders buying/selling in units of 100,000 shares could account for the entire trading volume. Of course, this number can be much higher or much lower, but you get the point. Gauging the sentiment of 200 traders is a lot easier than gauging the sentiment of thousands of traders for more popular companies. Additionally, penny stock day traders tend to be more vocal about their opinions on a stock. Understanding the market sentiment does not happen overnight nor does it happen intraday. Understanding the sentiment surrounding a stock can take days, weeks, and even months. Here is how I do it:
First things first, I like to find a stock that appeals to me. I make sure the stock has enough daily volume and investor interest to run when given the chance. Through a combination of fundamental and technical analysis, I create a watchlist of a few stocks at a time. As days go by, I watch how the stock trades. I pinpoint key support and resistance levels and start thinking of a good buy-in point. I also like to see how the stock reacts to different catalysts. What happens when news is released? Is anticipation building over an upcoming event? How does the market react to large sell orders? Watching the price action relative to different catalysts can be extremely insightful. However, if you want to truly understand market sentiment, you need to be more thorough. Focus on the psychology behind each of these moves. Luckily, penny stock traders tend to be very vocal about their opinions and even their actual buy/sell orders. Read message boards like Investors Hub. Browse Twitter, or use a tool like StockTwits. Check Facebook, LinkedIn, and other sites. You can never be too thorough. Read what people are saying and analyze it. After you believe you have done a thorough analysis, determine whether the market sentiment is positive or negative. You should also determine the strength of the sentiment. If the sentiment is strongly positive, the stock may move upwards in a day. If the sentiment is just slightly positive, it may take a few days to move, as the market will wait from confirmation from other traders. You will also want to make sure the stock has enough volume to move. This means you will want a lot of people to be talking about the stock, and not just a small group of loyal followers. Do not let your personal biases get in the way. Here is an example:
Awhile back, I traded a stock called PVEC. The company released a press release about a future dividend that would essentially give investors “free money” (Read the PR if you are interested in the details). I had never heard of PVEC before reading this article, and I had very little time to do research on the company. Instead, I analyzed the market sentiment surrounding the stock. People were raving about this new press release that offered investors free money. There was a strong positive sentiment surrounding the stock. Although there was some skepticism regarding the legitimacy of the dividend, this offer was too good for investors to refuse. So, after thoroughly analyzing the investor sentiment, I placed an order to buy shares at .0005/share. This was a Friday and I knew that the news would spread on the weekend. Did I believe the news? Not in the least bit. Did that matter? Not in the least bit. When I placed my order I knew almost nothing about the company, but that didn’t matter. What I did know was that there would be buying pressure on Monday and I could make a quick profit. Needless to say, on Monday, the stock ran up as investors lined up to collect their “free money.” I sold into the morning spike at a price of .0009/share for an incredibly easy gain of 80%. The validity of the news didn’t matter for this play, nor did the company’s fundamentals, the charts, or any technical indicator. All that mattered was market sentiment.
$580profitPVECLong Stock Easiest 80% gain ever. Company announced a dividend that was higher than the cost to buy shares. Let the hype machine take care of the rest..
Market sentiment is an aggregation of every trader’s strategy. It accounts for fundamental traders, technical traders, momentum traders, etc. This is why it is futile to argue about trading strategies with different traders. If all of the chart traders believe a stock price will go down, and all of the fundamental traders believe it will go up, one group is inevitably wrong. As someone who trades on market sentiment, you just need to be able to pinpoint which group represents the majority. You want to find stocks where there is a strong sentiment. If 80% of people believe a stock will go up and 20% believe it won’t, there is a good chance the stock can run. Whereas if 60% of people believe a stock price will go up and 40% believe it won’t, the stock may not move because the naysayers will have a larger voice.
Overall, this strategy has helped me make a lot of money. That being said, my analyses are not correct every time, and this is not a fool proof method. There is no such thing as a fool proof method in the stock market. Trading based on market sentiment should be viewed as a tool that gives you a competitive advantage. Of course, this tool requires that you step back from the overall market, and develop an unbiased point of view. People who get emotionally involved in their stock picks will have a difficult time gauging market sentiment. You need to remain calm and analyze the situation apathetically. As always, I recommend testing all new strategies with paper trading so you can get the hang of them.