Support & Resistance for Penny Stocks Trading
Support and resistance is a critical concept in technical analysis and one of the top 5 penny stock patterns that we can use to swing trade penny stocks.
In this article, we will discuss how to apply support and resistance with breakout and pullback penny stocks strategy.
What is Support?
When a stock is trading in a range for a period of time, the support is the lowest level of that range. For example, if a stock fluctuates between $1 and $2 in the past 3 months, the support level is $1.
What is Resistance?
Using the same example as above, $2 will be the resistance of that stock. Resistance is the highest level of a trading range.
How to Find Support & Resistance?
Support and resistance are some of the most powerful penny stock patterns that we can use to our advantage. Below shows an example of IGC where the stock trades in the range of $1 and $1.68 from August to the end of November.
As we can see from the stock chart, each time the stock approaches the support level of $1, it is a signal to buy the stock. On the other hand, when the stock rises to the resistance level, it's a signal to sell.
The longer the trading range, the stronger the signal. If a stock is trading in a range for one year, the signal is better than if a stock is trading in the range for 3 months.
For best results, we should combine support and resistance with other technical indicators and stock chart patterns.
How to Find Breakout Stocks
What happens if a stock breaks out resistance and goes higher. When a stock made a breakout, the resistance becomes the new support.
- The above PPSI chart shows the stock is trading in the range of $0.95 to $2.5 from April to September.
- Then the stock made a breakout and gapped up above the resistance with strong volume.
- The $2.5 resistance is now the new support.
When a stock breaks out a long term range, there are two popular strategies penny stock traders use.
The Breakout Strategy
A breakout strategy is when traders buy a stock when it breaks out of a long term trading range with strong volume.
A good entry point for PPSI is on October 6 when it gapped up above the resistance level of $2.5. The stock opened at $3.32 and made an intraday high of $9.43, which was 500% from the previous day's closing price of $1.57.
Sometimes, a stock will breakout a resistance only to go back down on the same day. These are what we call false breakouts.
False breakout often occurs when the trading volume is not strong during the breakout. The stronger the volume when a stock breakout, the less likely the stock will pull back.
When using the breakout strategy, we should always use a stop loss to protect ourselves. The stop loss should be placed a little below the resistance price so that we don't get shaken out of our trades easily.
Also, we should set a price target for profit taken, because most penny stocks may drop over 60% after they made big moves. That means we should get out as soon as we hit our target price.
The Pullback Strategy
Another trading strategy that we can use is the pullback strategy. Since most penny stocks go back down after their big rise. We can wait patiently for them to back to the new support or the previous resistance for a new buy entry.
As we stated above, when a stock breakout of resistance, the resistance becomes the new support. After a stock made big moves and then pull back to the new support, it triggers a buy signal for our pullback strategy.
Using PPSI as an example, right after the stock made an intraday high of $9.43 on Oct 6, it pulled back to a low of $2.34 in three weeks, which is a 75% drop.
- The old resistance or the new support for PPSI is $2.5.
- Our goal is to buy the stock around support.
- If we buy the PPSI at $2.5 at any time from Oct 28 to Nov 10, we would enjoy the ride when the stock rises for the second time.
Again, we should set a stop loss and price target for our trade. The stop loss should be placed below the support so we minimize our risk.
We should set a target for profit taking because we will never be able to sell the stock at the highest price. By setting a target price, we prevent ourselves from holding a penny stock for too long. Remember, most penny stocks go down right after their big moves. We don't want our greed to take over us and turning a profitable trade into a loss.
When to Cut Losses?
When a stock drops below the support level, it is a bearish signal. The bearish signal is even stronger if the trading volume is high. For long traders, it is a good idea to sell their position to cut losses.
Let's take a look at the MDVL chart.
The stock is trading above the support level ($14.04) from August to mid-October.
On Oct 20, the stock drops below the support level which generates a bearish signal. Within five weeks, the stock dropped to a low of $9 before bouncing again. The drop from support to the new low is about 36%.
MDVL retraced 74% from the intraday high of August 5. Traders who jumped on board on that day got crushed. This stock proves that we should always set a profit target for penny stocks because what goes up must come down.
Support and resistance are useful to find the general direction of a stock. Stocks trading sideways may not have support or resistance. We can easily skip these sideways stocks and focus on the ones that are trending up or down, and use support and resistance to help us find entries and exits.
As you can see, support and resistance can change quickly when a stock breaks out of resistance or drops below the support. As a trader, we must adapt to the market, and cut losses when necessary. It is impossible to time the market for maximum profit, but we can control our risks by only entering a trade at optimal prices.
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