Beginner's Guide To Trading Penny Stocks: Part II

Which stocks do I buy?

You'll want to decide which stocks to buy based on many factors. The elements you choose to favor when deciding if something will make a good trade becomes your trading style. The two most influential things to consider though are the technicals and the fundamentals. Technical analysis tends to be more important for penny stocks so we'll talk about that first.

What is technical analysis?

Technical analysis concentrates on the price action of the stock in an attempt to identify strategic buy and sell points. In other words, you look at how the stock has traded in the past to predict how it will trade in the near future.

This chart is choked by a slew of technical indicators (those straight lines moving across the graph). Each one purports to tell you something different about the stock in question. Luckily for you, most of them aren't worth learning when it comes to analyzing penny stocks.

Basic technical analysis, and what I rely on most when determining my trades, examines just two things: support and resistance.

In this graph, I've drawn lines to mark the areas of support and resistance. They are determined simply by where the stock has been. We can see that the stock hit the one dollar mark twice in the past then bounced back, thus establishing the one dollar area as support. If the stock were to bounce off the one dollar mark again, that level of support would be strengthened. The more times it hits a support level and fails to break below that level, the stronger it becomes.

The same is true of the resistance level. We can see that the stock hit the $1.43ish level twice, then fell back down. We can then say that this stock price is a resistance level. You can also see that the price action tended to hang around the 1.40 level a bit. This is mostly because it's human nature to favor nice round numbers so people set their trades there more often than they would at some other arbitrary number like say $1.37.

So how do you use this new information? Basically you use these levels to maximize your potential gains, and minimize your potential risk. Continuing with the example of the CLDS chart above, you wouldn't want to trade it at it's current level of $1.25 because it's mid-range of it's support and resistance levels. There's no reliable way to predict if it will go up or down from this point so you're better off not trading it. On the other hand, if the stock fell back to the one dollar level you could consider buying because that level offers support. It also allows you to create a logical trading plan before you even enter into the trade. Your plan might be something like, "I'll buy this stock at $1 and look to sell it at $1.40 where there is resistance. If the stock falls below $1, the support level, I will immediately close my position for a small loss."

The reason why your plan accounts for the breaking of support below one dollar is because the breaking, or collapse of support, is a strong bearish sign. It indicates that the stock will go down so you won't want to have a long position in that stock. A long position means that you've bought the stock in the hopes that it will rise in price.

Which stocks do I sell?