Penny Stocks & Day Trading Strategies for Beginners
Usually, new investors hear about Warren Buffet and think that the best thing to do is invest long-term. However, this is not necessarily true, especially when it comes to penny stocks. The way people like Warren Buffet approach the stock market can mean several years or decades to realize a significant percentage return.
But with a large inflow of money, a small 2-3% gain equates to a large amount of capital returned. What about those who don’t have billions of dollars under management? While there are plenty of ways people can invest in the stock market, there are other ways to take advantage of short-term momentum. This is where we find people day trading.
What Is Day Trading?
Day trading is basically buying and selling the same stock during a single day’s trading session. There’s also “swing trading,” which involves buying and selling penny stocks within a few days. The mindset behind the approach is that small gains every day will build up, equating to a large increase in capital.
The biggest problem that new day traders have is that they think they can go in without a strategy. This results in consistent losses instead of gains for the trader. With plenty of “meme stocks” floating around on places like Reddit, due diligence is one of the most important things to perfect.
Another problem with day trading penny stocks revolves around some brokerage firms. Not all of them can accommodate the volume of trades that day traders make. Some brokers like TD Ameritrade, Tradestation, Charles Schwab, and others have the ability to cater to day traders. These penny stock brokers need to provide good charting tools, real-time quotes, and take complex orders quickly.
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The most annoying problem for new day traders mainly impacts those starting with smaller accounts. The Securities and Exchange Commission states that you may only place 3-day trades within a 5-day trading period. This is called the pattern day trader rule. Obviously, it is extremely limiting, but it only impacts those with account sizes under $25,000. It applies to all traders, too, not just those buying penny stocks.
Penny Stocks & Day Trading Strategies #1: Harnessing Knowledge
Knowledge is a trader’s best friend regardless of whether you trade short or long term. Day traders must stay on top of overall market news, government actions impacting the markets, and individual company news.
First, make a list of penny stocks that interest you. Then, do research on the companies and the sectors they are in. Also, consider other things like economic outlook or major geopolitical factors when you make a list. There are so many internet resources that provide traders with the necessary information to make informed trades.
#2. Set Money Aside In Case You Lose
Remember, day trading involves placing trades during the span of a day. This means you must allocate your portfolio properly to minimize risk and have enough capital to place other trades.
Smaller trades help traders lose less money and protect their portfolios from a bad trade. However, trade sizes vary on the amount of risk and portfolio sizes a trader has. When you are first starting to day trade, you should use funds that you can afford to lose. A good alternative to this is paper trading. Plenty of websites offer trading simulators that allow users to practice trading. While you won’t make money with a good trade, you also won’t lose it with a bad trade.
The most important thing to remember is that perfecting a trading strategy takes time. It can be tempting to jump right in and follow the pack, as we’ve seen with stocks like GameStop and AMC this year. But the fact of the matter is that there will always be another trade. Don’t let the Fear of Missing Out (FOMO) cloud your mind and ignore establishing a strong trading strategy that will pay off for the longer-term.
#3. Should You Plan Your Day Around Trading?
Day trading is a serious time commitment. An effective penny stock day trader is one that puts in time and effort. This means things like being up an hour before the markets open, planning your strategy for the day. During this time, you will also look for the best penny stocks to buy.
But does your entire day need to revolve around trading? There are two schools of thought to this. The first says that you should trade all day. Spend the market’s open hours looking for opportunities to make money. There’s nothing wrong with this. But there are also plenty of day traders and swing traders making money with penny stocks without focusing on the market all day.
Some of them take up a strategy that allows them to trade penny stocks during the day, make money, and take the rest of the day off. Also, when it comes to swing trading, some traders will build a position in certain stocks, hold that for a few days or weeks, then cash out once their profit targets have been reached. How much time you spend trading penny stocks is up to you and your personal goals. But by no means are you required to be there when the stock market opens and stay until it closes.
#4. Learn First Then Trade Later
It’s okay to struggle when learning a skill for the first time. Most people will not succeed at day trading right off the bat because there is no exact science. You can either start trading with small sums of money or develop your strategies by paper trading.
The biggest downside of paper trading is that it will not prepare you for putting your money on the line. It can be a completely different feeling and you will understand when you start to dip your toes into day trading. A good rule of thumb is that until you’re confident in testing your strategy, paper trading is your #1 friend. The most important part is to get in the mindset of whatever money is in your paper trading account, treat it like it’s real.
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Furthermore, set up an account similar to how you will when you start trading with real money. If you plan to begin with $5,000, then your paper trading account should mirror that.
#5. Timing Of Trades
There are many different approaches that day traders make when placing trades. More experienced traders might place their orders so that they execute the moment the market opens. However, other traders like to evaluate the volatility and momentum of penny stocks before placing any orders.
There’s no specific time of the day to trade or not. For example, 10 AM EST isn’t better or worse than 3:30 PM EST. It all depends on where trading momentum is at the time you’re looking at the stock market. Furthermore, you can also monitor different momentum sources when news, filings, or global events come to light. When news came out about the current administration’s plan for building up an alternative energy future, many oil & gas stocks plummeted. At the same time, however, we saw a big move in solar, wind, hydrogen, and other green energy penny stocks.
When it comes to “timing,” it’s also important to know that rarely if ever will you sell at the very top or buy at the very low. Understanding how to read charts and research using technical analysis can come in handy. Plotting a move and identifying things like strong support and resistance can help you pick price levels for buying penny stocks and then doing the same when it comes time to sell.
#6. Utilize Limit Orders
This section comes back to the idea of trading with a sound strategy. If you have decided that the most you are willing to lose is $100, stick with that. Choosing a “percentage” for “max pain” might not be the best strategy. Let’s say that you’ve got a $1 stock trading heavy volume. The chart shows strong support at $0.91. But you’ve decided that you’re only willing to risk 5%. So you set your selling point at $0.95. Well, guess what, while the stock might’ve broken below your 5% threshold, the chart’s $0.91 support level held, and that penny stock might’ve gone on to bounce to highs of $1.20 or more.
Aside from knowing how to read charts, the most effective way to guarantee that you adhere to a plan that limits your loss is to have limit orders in place. Whether it’s a physical or mental limit, these types of sell orders can prevent you from taking big losses when day trading. On the flip side, limit orders can also allow you to achieve a more optimal price when buying volatile penny stocks.
Let’s say that the same $1 stock is bouncing between $1 & $1.20, and “right now,” it’s trading around $1.20. You know there’s a good chance of it dropping back down again. So you could set a limit order to buy at $1.03 because you’ve seen that level as relatively stronger support on the chart. Instead of doing a market order and paying a higher price, your limit order will ensure a better cost average if you’re right about the stock’s trend.
You will notice that you will have many trades ongoing simultaneously as you become more advanced at day trading. Limit orders will help you buy and sell at the prices you want when you cannot monitor certain stocks.
#7. Understand What The Actual Profits Are
No trader shoots 100%, never forget that. The goal is to make more money on good trades and lose less money on had trades. Another thing to be aware of, even though penny stocks can swing 10% or more in a day, is not to hesitate to take profits if you’re up. A penny stock can quickly swing in the opposite direction and result in you gaining 0 profits because you got greedy.
One of the strategies that some traders use to maximize gains and limit losses is called tier trading. It involves splitting up your capital and buying stock in different tiers. Let’s say, for instance, you’ve got $1,000 you want to spend on a trade. Instead of buying $1,000 worth of a penny stock all at once, you break your buys into something like $250, $500, and $250.
You “dip your toe” with a smaller starter position ($250) to see if you’re right about your trading thesis. If you are and the stock increases, look for a second tier ($500) at a higher support level. As the stock climbs, you “tier out of” or sell-off pieces. You may also be buying more too. The main point is that it keeps your cost basis lower while a stock climbs, ensuring you an optimal price.
Now, let’s say that stock doesn’t do what you think it was going to. Now you’re taking a loss on only $250 of your $1,000 total. A 25% loss on $250 is much less than a 25% loss on $1,000.
#8. Keep A Cool Head At All Times
It’s okay to lose sometimes; it happens. However, you cannot let losses affect your psychological state when trading. This results in impulsive revenge trading with no planning and will most likely cost you even more money. Just like you wouldn’t want a rattled surgeon doing your surgery, you should not be rattled when trading.
#9. Stick To Your Game Plan
Remember how I said that penny stock trading takes time? This “time” mainly goes into formulating your trading game plan. So why would you spend all that time putting together a plan to ignore it when it comes to day trading?
It is a waste of your time and money to neglect a plan you worked hard to formulate. The best day traders can work many trades to perfection. That’s because they have already created a plan. If your plan says sell at $1, then sell.
There’s no point in breaking your plan because of “hope” or emotion. If you “sell early,” reset, and observe the trend. The fact of the matter is that a strong trend will offer more entry opportunities later on. A weak trend will ultimately break down. Plus, no one ever went broke taking profit.
Hurdles To Overcome With Penny Stocks
One of the biggest things is fully understanding the time commitment it takes to become good a day trading. It takes a lot of practice and experience to come up with strategies you are comfortable with.
An interesting thought to remember is that you are just a single investor in the entire market. You are going head to head against people who have been trading for decades and have resources from trading firms. These people almost always succeed with their trades in the end.
Then there is the government that cuts down your profit margin due to short-term gains taxes. These apply to any investments that you hold for less than 1 year.
Deciding Which Penny Stocks To Buy
Because penny stock day traders tend to use smaller amounts of capital, they focus on stocks with certain requirements. These include volatility, technical trends, and trading volume.
Volatility refers to how much a stock’s price changes during a given trading session. Because penny stocks tend to have higher volatility, day traders have a lot more potential for higher profits. However, this also means that there is a lot more risk and can also result in heavy losses.
Identifying different technical trends can also help you decide which names on your list of penny stocks have a higher and lower potential for gains. The chart with no established trend and many single-day volatility spikes may not be the best one to look at if you’re a swing trader. On the other hand, the chart with a slow, steady uptrend with 1-day moves of less than 2% may not be best if you’re a day trader. Deciding which penny stocks to buy depends a lot on your personal style.
Trading volume might be one of the most important factors to look at when trading penny stocks. Volume is the amount of stock that is bought and sold during a trading session. Traders will usually compare the average daily trading volume of a stock to its current volume to evaluate interest. Also, if a penny stock lacks volume, it can be tough for a trader to exit a position.
Chart Patterns
Through technical analysis and candlestick patterns, day traders can make precise game plans to get the most out of penny stocks. There are so many different technical indicators and patterns. An important factor with technical analysis is volume because it acts as a confirmation for many indicators.
Doji’s, flag patterns, and support and resistance lines are some of the most widely used indicators for identifying chart patterns. A doji is used to show a potential reversal while flag patterns indicate continuation. Both patterns must have a surge of volume to execute properly. If you see the pattern form with rising volume levels, get ready to buy the penny stock.
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The next step is to evaluate the price where a stock struggled to get past. This is known as resistance. Typically, resistance lines are good points to sell at because they tend to hold. However, with a strong stock, you could sell some shares at resistance and hold the rest for another move upwards.
Penny Stocks & Risk
I feel like I have said this a lot now but have a game plan. Given the number of times this has been stated, you should understand its importance. One crucial decision when placing a trade is understanding how much you are willing to lose.
This is the part of the game plan where you decide your stop-loss. A stop-loss order is placed to set a hard sell at a given price point. They are perfect if you are looking at many stocks simultaneously or if a penny stock suddenly flips.
So how exactly do they reduce risk? Here’s an example that will make it very clear. Let’s say that you buy a penny stock at $1 per share, and the chart shows a potential support level $0.20 lower. At the same time, you have trades placed in 5 other stocks. You place a stop-loss order around $0.80 in the event the trade turns south.
After placing that order, you look at how your other trades are panning out. But, during this time, the other penny stock took a nosedive and is down 50%. Instead of losing $0.50 per share, you only lost $0.20 and saved a huge hit of $0.30 per share.
The most difficult thing about risk tolerance is understanding your own. This is important because knowing your limits can save you money in the long run. It is okay to take a break if you had a bad trading day. But understanding certain thresholds is important, especially when it comes to day trading.
Some Closing Thoughts About Penny Stocks
Day trading penny stocks can most definitely be a viable trading approach. As long as you can dedicate time and some capital, day trading is worth learning. By no means is it an easy task to learn, but it definitely has its benefits. You get to be your own boss, and the better you get, the more money you will likely make.
To recap, always make a game plan before investing in any stock. Go in with a solid entry point and exit point. Also, make sure to set your stop losses accordingly. Research the companies you are going to trade in because they might have catalysts you were unaware of. Do not be afraid to spend time paper trading also to develop your plan. If you have learned anything from this day trading guide, it’s not one size fits all. Don’t be afraid to test and experiment with different strategies.
