Technical analysis is the go-to method for finding opportunities to buy penny stocks. You can check for things like high penny stock trading volume, spikes in stock price, and myriad other options. As a penny stock trader, it would add more tools to your trading toolbox if you can understand technical analysis. However, beware the method of TA for penny stocks is not exactly the same as those for larger-cap stocks.
Penny stocks require a different set of rules which you must be aware of. The price movements are different in low priced markets, which is what penny stocks are all about. While it is true for all trading that demand and supply determine pricing, for large caps, investors are more swayed by a number of other factors. Thus, the valuation of these stocks is much different. Various other factors also play a role when compared to penny stocks.
Penny Stocks & Valuation
Penny stock valuation is different as there are no substantial data points to value it in comparison to blue-chip stocks. With no fundamental data like earnings, revenues or business plans, it is opaque to value the pricing. From a mathematical point of view, the theoretical trends of the past values are the best pricing ranges one can expect from penny stocks until the equities prove otherwise; hence all-time highs and lows.
Therefore, you can understand how the pricing is not a result of the perceived value of a penny stocks company. It’s likely due to some external reasons, which might be more a part of short term market momentum. Even if there is a legitimate case on account of some penny stock news, the results keep the prices to move wildly.
Two rules of thumb are summarized for penny stock technical analysis:
- Finding a stock at lower points of its historic trading channels. This is also known as potential levels of support.
- When the price and volume start picking up then it means there is interest in the stock, which could be a sign to start watching that particular stock for a move.
It will be difficult for fundamental analysts to work with the first rule as they are more used to looking at the historical earnings and performance of the company. The second rule is difficult for people who live by TA only, as it never gives a sure-shot chance of entry levels.
Overall, you need to be good at both: fundamental and technical analysis. In many cases, certain penny stocks can be fueled by momentum alone. But it’s good to know how to study fundamental trends as well. If a stock begins trading on sheer market momentum and then a material event happens, you’ll know that the event itself could act as a new catalyst for a continued move higher. We’ll go over penny stock fundamentals in a later article.