How to Play Small Momentum Stocks

For the active small-cap trader, momentum stocks are a great way to make fast gains. But when you’re flipping the market’s strongest stocks, there are a few rules you need to follow to maximize your gains— and protect your profits…

• Do your homework. The more charts you look at on a nightly basis, the better prepared you will be when the morning bell rings. I recommend familiarizing yourself with as many charts as possible, then assembling a short, manageable watch list from your trading universe. Starting your trading day with 30 or 40 stocks to watch just creates confusion— and increases the chance that you will miss a big mover.

If you consistently review charts and screen for relevant criteria every night, your stock vocabulary will increase as the months go by. Familiar names will begin to appear and reappear in your screens, and you’ll even get to know how certain stocks and sectors “behave” relative to their counterparts. This experience is invaluable, especially when it comes to making quick trading decisions. Once you begin to recognized stocks that made large runs in the recent past, you’ll be able to spot a new move and capitalize on it right away.

• Identify manipulated stocks. Some charts are too good to be true. When you see a perfect penny stock chart, you might be looking at a promoted stock. Promoted stocks can produce spectacular runs. But they all end the same way: the stock crashes, sometimes losing as much as half its value in just a few hours.

Anytime you come across a great looking OTC stock, you should run a quick Google search to see if anyone is promoting it. The promotions are fairly easy to spot, since they prominently feature the company’s ticker and boast outlandish “price targets.”

You can, however, still book strong gains with manipulated stocks. You just have to trade them carefully. There are several things you have to watch out for when trading them. One of them is the controlled shakeout. The shakeout is not the “dump” that so many people associate with pump and dump stocks. With a promoted stock, you never know when the dump is coming, but you know it when you see it. A dump occurs after the manipulation had ended. There’s no more support from whoever was involved in the pump, therefore no one left to support the inflated stock price with additional buying. When the dump happens, shares fall far and fast.

Controlled shakeouts happen when the stock loses a few points and then miraculously finds support. Manipulators usually walk the price back up by the afternoon or the very next day. The purpose of this move is to “shake out” weak hands and large positions, and to attract early short sellers. This can result in a short squeeze once the rise is restarted, producing a significant pop in share prices.

• Don’t force your trades. Sometimes the market will work against you. Most or all of the picks from your watch list might open in the red due to a weak market. If this is the case, don’t force a trade. You don’t always have to be trading. In fact, a few carefully selected trades per months usually perform better than throwing darts. You have to pay your broker every time you buy and sell—so make all of your trades count.

If several of your potential momentum plays do open in the red on any given trading day, you should still keep an eye on them. Sometimes after morning profit taking, the stock will rebound into the green. This is a powerful technical move that can ignite a major surge in the share price. Buying when a stock moves from red to green is a great risk/reward play that many successful traders look for.

Sincerely,
Greg Guenthner
Penny Sleuth

March 23, 2011

How to Play Small Momentum Stocks was originally featured in the Penny Sleuth. Check out Wall Street’s 5 Most Profitable Penny Stock Patterns Report.

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