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.
Day traders deal with so many tickers every day and it can be difficult to keep track of each and every one of them. All day traders have a different strategy for finding stocks to play. From stock scanners to trade alerts, there are plenty of ways to find good stocks to play each day. Regardless of how you find your stocks, you will always want to know why a stock is moving. Knowing why a stock is moving can help give you determine the magnitude of the move. I find most of my plays using a stock scanner so I have very little information when a stock is moving, other than the fact that it is moving. I don’t think I need to convince you that it’s important to know why a stock is moving, so let’s get straight to the point.
How to Find Out Why a Stock is Moving.
This list is in order of which to do first. Usually you can find out why a stock is moving from the first few items, but if you can’t, the others can be helpful.
Look at the stock chart for multiple time frames – First things first, I will look at a stock chart for the ticker I am interested in. I will look at the intraday trend, the short term trend, and the long term trend using a few different charts. This can help give you an idea as to how the stock trades from a historical perspective. It can also let you know if the stock is moving on a technical breakout. I use my trading software for charts, however, you can always use StockCharts.com.
Check for news – Most of the time, when a stock is making a big move, it is due to a news story or press release. I will check Yahoo Finance, as well as some other sources, to see if there is news moving the stock. This also includes analyst upgrades/downgrades. I will analyze the news to see how good/bad it is and try to determine how much it can move the stock.
Check for a Seeking Alpha article – Sometimes, when there is no news on a stock, there may be a Seeking Alpha article. These articles have been able to move stocks a lot as of recently. Sometimes, the article will be shown on Yahoo News, however, sometimes it won’t so I check the actual Seeking Alpha website.
Check the message boards – While message boards are usually filled with useless banter and wild predictions, they can be helpful to check when a stock is moving, especially if it is a penny stock. You have the advantage of a large group of people all working together to provide information. You can usually discover what is moving the stock because it will be mentioned on the board. I use Investors Hub as my go to message board. Don’t get caught up in listening to people’s opinions. Focus on the facts and learn why the stock is moving.
Check Twitter – This is similar to checking a message board. Just do a search for your stock name in the Twitter search bar with a dollar sign in front of it (ex: $AAPL). Sort results by “All” instead of “Top”, and you can see all of the most recent tweets about your stock. Sometimes you can get some valuable insight. Once again, focus on facts not opinions.
Check for a stock promotion – Stocks can move a lot when being pumped by people with large email lists. There are a few websites that keep track of these promotions. I like to use the Stock Promoters website to check quickly. I also subscribe to a lot of penny stock newsletters so I can find out earlier.
Check for a short squeeze – A stock can run exponentially when shorts get squeezed out of their positions. I like to know how many shares are short and how many days it would take to cover. You can use the Short Squeeze site for some bigger stocks or OTC Short Report for penny stocks. I don’t think this data is always 100% accurate but it is still good to know.
Check SEC Filings and OTC Market Filings – Sometimes a stock will move based on a recent SEC filing. Check the EDGAR website or the OTC Markets (for penny stocks) to see if a company just released an important filing.
Check indices and sectors – Some stocks move with the market so it is important to know what the market is doing. I pay attention to larger indices like the S&P 500 (SPY), Dow Jones Industrial Average, and Russell 2000. I will also check certain sectors to see if they are “hot” an a given day. I use my stock software to get this information, but you can always check a site like Bloomberg to get your information. This kind of analysis is best for bigger board stocks like NASDAQs.
Finding out why a stock is moving is just the first step. You will want to create a solid plan for trading the stock next, but that’s a completely different topic. The process outlined above is simple:
Find out why a stock is moving
Determine the magnitude of the move
Create a plan to trade the stock
You can also use the resources mentioned above to find stocks for the next trading day. Knowing why a stock is moving provides clarity in the market and can help you become a better trader. The more you know about the move, the better.
Most people are aware of how supply and demand works. Chances are you learned it for school, business, or some other reason. It is an extremely basic concept, yet a lot of people tend to forget how applicable it is. I don’t really care about how supply and demand works at a macro scale. I’ll leave that to the economists. What I do care about is the psychology behind supply and demand because it affects the markets. Before we move on, let’s look at a basic supply and demand chart and draw some basic insights.
I’m sure you’re familiar with this chart, but a good refresher couldn’t harm. You can draw a lot of insights from this graph, but there is one I care most about for this post.
As supply goes up, demand goes down.
Yes, this is very basic, but start to think about it in terms of the stock market. The psychology behind it is extremely powerful.
When it comes to the market, “supply” would be the sell orders, or the ask prices, and demand would be the buy orders, or the bid prices. This is how you should be thinking of Level 2 screens. They are simply supply and demand tables.
Now, that we look at a Level 2 through a supply and demand lens, we can understand how every single order affects the balance of the stock market. Now, let’s draw one more insight from the supply and demand chart before we move on.
As demand increases, or supply decreases, price goes up.
As supply increases or demand decreases, price goes down.
Let’s apply this to the market. As the orders on the bid side of a Level 2 screen increase in volume and price, the stock price goes up. As the orders on the ask side of the Level 2 screen increase and volume and decrease in price, the stock price goes down. This is still basic economics, but it needs to be understood before we move on.
What is the point of all this?
I get it, you didn’t like economics in high school, so why am I bringing it back to haunt you now? The answer is simple; understanding how supply and demand works can help demystify a Level 2 screen. Level 2 screens may look complex, but they are incredibly simple. You need to understand how they work before you can gain any valuable insight from them.
The bigger point here is learning how to time your entries and exits properly with respect to supply and demand. This is incredibly helpful when dealing with illiquid penny stocks. I don’t put as much thought into this when dealing with higher volume big board stocks that trade thousands of shares per second. There’s usually not enough time to do an in-depth analysis. For illiquid penny stocks, analyzing a level 2 screen from a supply and demand perspective can give you great insight into how a stock will perform on any given day. I use this type of analysis to predict how certain stocks will perform during a day based on supply and demand. I will also place my orders in a way that will be most beneficial to my end goal.
Let’s look at an example
Here is an example that comes straight from today’s trading session. Before scrolling down to see my insight, do a quick analysis to see what you can infer from this Level 2 screen.
For the first three price levels (as shown by different colors), we can see this:
There are 185,000 shares on the bid side (demand).
There are 1,626,000 available on the ask side (supply).
So, supply is greater than demand, and, as we know, that is an easy way for a stock to go down in price. Yes, other factors play a role, but this article is focused on Level 2 analysis. Does this mean the stock will automatically go down? Of course not, but it would be much easier for the share price to go down than it would to go up because it would take less volume.
This is intended for determining intraday trends, as the Level 2 screen will change the next day. Also, keep in mind that supply and demand levels can shift intraday, with or without a catalyst. The supply and demand distribution can help you understand the psychology of the traders involved in a given stock.
Here are some insights we can take away from this Level 2 screen.
Buyers are in control – There are so many people trying to sell this stock, yet only a few people trying to buy it. Sellers are trying to unload over 1.5 million shares. If they sold into the bid, they would drive the price down too far and wouldn’t get the exit they desired. Therefore, someone who is bullish, can take advantage of this setup to get cheap shares. If someone put in a buy order for 500,000 shares anywhere between .0042 and .0045, they would be offering the sellers a chance to unload a lot of shares. The order may not get filled, but that is okay. It’s not like there is a lack of shares available.
Sellers are being foolish – This is by far one of the most frustrating things that can happen when trading these kinds of illiquid penny stocks. A stock will be having a slow day or be moving up gradually and someone will try to unload a large amount of shares. People complain about this all of the time, often referring to these huge orders as “walls” or “blocks” on the ask. These walls deter buyers from buying shares at the ask price, because there are so many shares available (Supply is greater than demand). Buyers want to buy shares when they think a stock will go up. A huge “wall” on the ask makes it difficult for a stock to move up. Notice that there were only 3.3 million shares traded this day. Yet, someone is trying to unload 860,000 shares in one order. It would take roughly 25% of the daily volume to fill that order alone and there are still plenty of other orders that need to be filled. I don’t like complaining about other people’s trading styles, because they should just be accepted as part of the market environment. That being said, there are certain strategies that are counter productive. When you put a huge block of shares on the ask during a low volume day, you are hurting your own cause. You want to sell your shares, yet you are creating a supply and demand distribution that favors buyers. Think about it. People don’t line up hours in advance to get the new iPhone because they know there are plenty to go around. They line up because they know supply is low and demand is high. People are literally fighting to spend their hard earned money on an expensive product. Do you think there is a low supply of iPhones because Apple didn’t have time to make enough? Don’t be naive. Apple understands supply and demand and uses it to their advantage. Sure, it would be nice to sell a ton of phones all at once, but, ultimately, that would hurt their cause. The point is simple. When you are selling shares, you need to do so at the right time and in a way that will support your end goal. This leads to my next point that combines my first two points.
Some days are meant for buying, others are meant for selling – As a swing trader, it is crucial that you understand this. Not every day is going to be a good day for selling shares and you cannot be panicked by price dips. Some days are meant for buying, even if you already have shares. A simple look at this level 2 would tell you that sellers outnumber buyers, and, therefore, buyers are in charge. If you are looking to buy shares, this would be a great day. If you are looking to sell shares, you will want to wait because every order you add to the ask (supply side) gives the buyers more power. When buyers are in charge, it doesn’t mean the long term trend will be bearish, but the daily trend certainly won’t be bullish unless the supply and demand levels shift. Success in the stock market is all about seeing what others don’t. You can take advantage of panic, greed, and hype if you have good foresight. Trying to sell a large amount of shares on a day when buyers are in charge is like showing your hand in a game of cards. You are giving your opponents an advantage. You are saying “I am willing to sell all of these shares at this price” when there is a slim chance that you will ever get your order filled. Now buyers know your exact plan, but you don’t know theirs. Maybe buyers were willing to pay more for the shares before they saw how many you were willing to sell at a certain price. Maybe they would have bought your shares progressively if you didn’t show them all at once. Be smart. Test the waters and see what buyers are willing to do. Start with a smaller order and see how buyers react. The same thing applies to buying shares. No need to put in a huge order as the highest bid. Start small and see if the sellers come to you. Sure, you may rack up some more broker commissions, but you will have a better plan that will make you more money in the long run. In short, understand whether the level 2 setup for the day favors buyers or sellers and plan accordingly. Be smart and be patient. You may want to get in or out of a stock fast, but planning entries and exits properly is far more important.
You can “manipulate” a level 2 screen in your favor – Last but not least, understanding the supply and demand distribution can actually help you manipulate a stock in your favor. The word manipulate can have a negative connotation, but that is not the case here. You are not doing anything shady. You are simply placing strategic orders to support your end goal. On this particular day, sellers were clearly in charge. Buyers wanted to buy 185,000 shares and sellers wanted to sell 1,626,000 shares. There is an imbalance. Anyone who looked at the Level 2 screen would be hesitant to start buying shares because the price could drop fast if someone sold into the bid. If you want to show the market that there is more demand for this stock, you can create that demand by building bid support. If you placed a few orders totaling 1,000,000 shares on the bid side, there would be a better balance. Of course, you better be prepared to pay for those shares, however, sometimes, just showing the bid support is enough to push a stock price up. You should never use this solely as a bluff, but if you are bullish on a stock, you can use this strategy to share your sentiment with the market. The market may see the bid support and decide to buy on the ask because they have a nice safety net if things don’t go as planned. This is most feasible when you already own shares and want the price to go up. Otherwise, it is pointless. Think about this. If you have been watching level 2 screens for awhile you have definitely experienced this setup. A stock is running up or down and then it hits a huge order on the bid or ask. This order acts as a wall because it would take a lot of shares to break past it. A lot of the times this order won’t even be fully filled, but the fact that it is there is enough. For example, let’s say a stock has run from .03 to .035 intraday on 10 million shares of volume. Traders are bullish until someone puts an order to sell 2,000,000 shares at .0351 on the ask and suddenly momentum slows. People make take chips off the ask but the stock bounces back down. The seller may only sell a few hundred thousand shares, but they were able to push the price down because they messed messed with the psychology of the market. All of a sudden, many traders will go from being bullish to bearish in the short term as a trend reversal may be in the works. This seller made it seem like it would be difficult for the stock to break past that point, so people start taking profits in case the stock drops. Of course, sometimes all of the shares will be purchased, which is why you never want to do this solely as a bluff. It is a tool and it needs to be used properly. This strategy should only be attempted if you know what you are doing.
This article ended up being much longer than I planned, however, there was a lot to say. The main point is that you need to understand how fragile the markets are and plan your orders accordingly. You can’t simply place orders at a certain price because it’s what you want. I’d love to get my ideal entry and exit for every trade, but that’s not always feasible. You need to react to the market conditions and place trades around them. Remember, there are traders who watch the level 2 screens for a stock all day. These traders analyze every order that comes onto the screen. You want to send the right message. Focus on what your order says to the market.
Always try to figure out whether sellers or buyers are in charge each day and formulate a plan accordingly. Think about the psychology behind the level 2 screen and learn to analyze it without emotion. Remember, your biases don’t mater in the short term. You may think a company is amazing, but if people are selling off, you will want to create a plan to react. Maybe you will increase your position that day. Maybe you will sell some shares to lock in profits. The choice is yours. If you can master the art of analyzing a level 2 screen, you will have a competitive edge over other traders.
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.