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How to Swing Trade Penny Stocks

Swing trading penny stocks is one of the most lucrative ways to make money in the stock market. Swing trading means buying and selling a stock within a short period of time, anywhere from a few minutes to a few weeks. This article will show you how to swing trade penny stocks and make money from the market.

Penny stocks are more likely to have double and triple-digit moves than bluechip stocks like Coca-Cola and General Electric. It is much easier for a $5 stock to double up than a $100 stock. Of course, there are exceptions like Tesla where the stock jumped over 1000% in less than two years. However, as with anything else in life, great reward comes with great risks. Penny stocks are extremely risky and it is not something that you can learn quickly. A trader must be dedicated to learning how penny stocks work in order to make money. There are two main skills that are needed to swing trade penny stocks successfully, technical analysis and trading discipline.

What is Technical Analysis?

Technical analysis is the study of chart patterns, price movement, and market psychology to derive a set of technical indicators aiming to predict stock price in the short term. Technical analysts believe what happens in the past will repeat again in the future because human nature doesn't change. A stock pattern that works today will continue to work tomorrow. Technical analysis consists of two parts, stock chart patterns, and technical indicators.

What Are Stock Chart Patterns?

Charting reading is a skill that every penny stock trader must learn to interpret stock movement and predicting which direction a stock would likely move.

Above is a sample candlestick stock chart for IDEX. Candlestick is one of the most popular and powerful chart types traders use to swing trade and day trade stocks. There are many other types of charts you can use such as line charts and bar charts. A trader needs to only pick one chart type and stick with it.

A stock chart is plotted by using a stock's open, high, low, and close pricing. You can also see the trading volume of the stock which is an important technical indicator that we will be discussing later in the article. By looking at the stock chart of IDEX, we can see the stock made big moves recently from below $1 to an intraday high of $4.75 on November 24.

How to Find Trade Setups

A support level was established on November 20th at the intraday high of $1.75. To learn more about support and resistance, read the Support & Resistance. For swing trading, one of the strategies is to buy a stock when its price is trading just above the support level and have a stop loss right below the support level to protect ourselves just in case the trade goes against us. Entry Point 1 For instance, a good entry point would be to buy the stock on December 02, when the stock dropped early in the morning and trades just a little above the support level of $1.75. If a swing trader was able to buy IDEX around $1.9, he would have made about 20% on the trade when the stock rebounded in the afternoon. Entry Point 2 Another good entry point is today as the stock is trading around $1.84 which is very close to the support level. Please remember we are not interested in holding penny stocks for the long term because most penny stocks go bankrupt. Our goal in swing trading is to buy penny stock with a good entry point and try to sell it for profit within a few days. If a stock does not move, we would sell the stock and move on to the next trade. Also, if a stock drops and hit our stop loss, we would also sell it.

Entry Point 3 Another strategy many swing traders use is the breakout strategy. Breakout traders buy a stock when it breaks out of a long term resistance. The longer-term resistance for IDEX was established on August 10 at the intraday high of $1.85. When the stock gapped up above $1.85 with huge volume on November 23, it triggers a buy entry. Traders who bought IDEX when the stock broke out its resistance that day would get paid handsomely. Just like the previous two entry points, a stop loss is necessary for any trade to protect our account. When a stock breaks out of resistance, that resistance becomes the new support. We should set a stop loss near or below the support level. To learn more about stock chart patterns, read top penny stock patterns.

What Are Technical Indicators?

Technical indicators are derived directly or indirectly from stock prices and volume. There are many different technical indicators invented by different traders to measure the trend, momentum, and volatility of a stock. Some of the popular ones are volume, moving averages, exponential moving average, MACD, RSI, Stochastic oscillator, Bollinger bands, and OBV. Let's go over some of the technical indicators and learn how to use them for swing trading.

What is Moving Average?

The simple moving average is a trend indicator that is used to identify the direction of the stock price. It is calculated by using the close price of a stock. Long term investors use a longer-term moving average such as 200-day, 100-day, and 50-day whereas short term swing trader use shorter-term moving average like 10-day and 5-day moving averages.

How Do Moving Averages Work?

Moving averages generate a bullish signal when a shorter-term moving average crossover with the longer-term moving average. For swing traders, when the 5-day moving average crossover the 10-day moving average, it gives us a buy signal. Using the IDEX chart as an example. The 10-day moving average is the red line, and the 5-day moving average is represented by the blue line. When the blue line crossover the red line, we get a bullish signal.

As we can see from the chart, the 5-day MA crossover the 10-day MA three times. Each crossover is shown in the blue oval in the above figure.

  • The first time the moving average crossover, IDEX went from $1.25 to about $1.75 before falling to under $1.
  • The second time when the moving average crossover, the stock didn't really go anywhere.
  • The third time when the 5-day and 10-day MA crossover, the stock went from under $1 to an intraday high of $4.75. A huge move indeed.

Drawbacks of Moving Average

There are two main drawbacks of using moving average

  • Moving average is a lagging indicator because it derives from past prices. The longer the time frame you use for moving average, the greater the lag. This means a trader might not be able to get on a trend early when a stock reverses its trend.
  • Moving average works only with charts that have a strong trend. When a stock is trading sideways, the moving average doesn't work well.

Because moving average doesn't always give accurate signals, we should not rely on it as a sole indicator. We should combine the moving average crossover with other indicators to get better results.

What is Exponential Moving Average?

The exponential moving average is developed to improve the simple moving average by giving more weight to the latest stock price. Just like the moving average, EMA is calculated based on the closing prices of stock by giving more weight to recent data. EMA produces a bullish signal when a shorter-term EMA crossover a longer-term EMA. The above IDEX chart shows a 5-day EMA and 10-day EMA. Each crossover is represented by an oval. In this chart, it gives us similar entry points as the simple moving average did. EMA has the same drawbacks as a simple moving average, therefore we should not use EMA as a sole indicator. Always combine EMA with one or more other technical indicators.

What is MACD?

Moving Average Convergence Divergence or MACD, in short, is a trend-following momentum indicator developed by Gerald Appel in the late 1970s. MACD is calculated based on closing price and exponential moving average and consists of three parts, MACD Line, Signal Line, and MACD Histogram.

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How Does MACD Work?

MACD generates a bullish signal whenever it makes a crossover, or when the signal line crossover the MACD line. In the above IDEX chart, the MACD made two main crossovers. The first time when the signal line crossover the MACD line, the stock didn't really go anywhere. However, the second time MACD crossover in mid-November, the stock made a pretty strong move in the next two weeks.

Drawbacks of MACD

Here are a few drawbacks of MACD.

  • MACD often generates a false signal that results in losses for a trader
  • MACD is also a lagging indicator because it is derived from price and EMA. In the rare case of MACD divergence with the stock price, it can become a leading indicator to detect trend changes.

As with any other technical indicator, you should not rely on MACD as the only indicator. You should combine it with 2-3 other indicators or chart patterns.

The Volume Indicator

Trading volume is the single most important indicator in technical analysis other than the stock price itself. For any technical pattern to have any meaning, it must be supported by trading volume. If no one is trading stock, no matter how great the chart patterns and the technical indicators look like, it would have no meaning. For a trade to occur, there would need to be a buyer and a seller that agrees to make the transaction at a particular price. When you trade penny stocks with low volume, sometimes it is hard to find a buyer to buy your stocks when you wanted to sell. You would be forced to sell your shares at a lower price.

How Does Volume Work?

There are two ways that you can use volume to your advantage in penny stock trading.

  • When a stock goes up with strong volume, it produces a bullish signal. The signal means there are more buyers than sellers and that may push the stock price higher. When you are going long on a penny stock, you want the stock to have a larger volume than the average volume for the stock.
  • When a stock goes down with strong volume, it generates a bearish signal which means it is time to sell. If you are holding stock and the stock is going down with huge volume, it may be time to cut your losses and move on.

Using the same IDEX chart, we see the stock made big moves with huge volume starting November 16. The volume keeps getting higher as its price climbing higher. This is a very bullish signal because it means there are more and more people getting on this stock. When the stock broke a long term resistance on November 20, its stock price shot up from $1.5 to a high of $4.75 in just three days.

Final Words

Technical analysis and chart pattern gives a trader an edge in penny stocks trading. By observing existing patterns, you can come up with a trading method that works for you. Spend time studying the market and learn how it works before trying to make money. In fact, money should not be the target of why you are trading penny stocks. Your goal is to improve your trading skills and money will come naturally as a bonus. To learn more about chart patterns and swing trading, read step by step guide to penny stocks trading. For a complete guide to technical analysis, read Technical Analysis of the Financial Markets.

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