Sunday, December 21, 2008

Penny Stocks - Playing With Fire

In an earlier entry I wrote about the dangers of investing in penny stocks, expressing the opinion that Lottery Tickets represent a better risk-reward play.

Need To Make $$$ Fast? Beware Stock Promoters

With that being said I also know that there are many who will be convinced that they can beat the system. With that in mind I thought I’d give you a bit of a road map into some strategies which I’ve found successful in the past. I won’t be making any recommendations about particular stocks, there’s plenty of that out there already. At the bottom of this post I’ll include a couple of links that you can use for research, but no stock picking sites. I can't emphasize the risks here enough, while I do think its possible to make some winning the long run I think the vast majority of players will lose. I also know that when times are hard people will often take major risks, and hopefully this will help those who are bound and determined to try anyway.

Realize firstly that almost all penny stocks are fundamentally garbage. They don’t have a history of ever making money from anything other than printing shares and dumping them into the market. As such throw out all the rules about fundamental and even technical analysis, because penny stocks move on one thing…promotion, often referred to as ‘Pump & Dump’.

Picking A Penny Stock
You’ll want to avoid anything that is currently being hyped, or has recently been promoted. As such I recommend looking at stock sites which show a graduated list by volume, and I’ll suggest you go right to the bottom looking for those stocks trading thinly or not at all. I realize this runs counter to what many will suggest, but you’re looking for stocks that are good candidates to be pumped in the future.

Check how many shares are issued versus the number authorized. You’re looking for stocks that have a large number of authorized shares that have yet to be issued. You can be pretty darned sure that when those authorized shares are dumped into the market it’ll be at a time when there’s lots of promotion and hype. If you see a stock with around 100 million shares outstanding and say 300-500 million authorized, I suggest that would be a good candidate.

Avoid stocks that have been putting out a lot of press. If you’ve zeroed in on stocks with little or no volume then this shouldn’t be an issue, but check nonetheless. A good method I found was to type the stock symbol into google along with the word “disclaimer”. If the stock has ever been pumped by a popular touting outfit it should show up as most have to disclaim that they're being compensated and how. Reading these 'toutsheets' will give you an indication of how long it’s been since the last pump. As a rule of thumb I’d stay away from any stocks that have been hyped in at least the past 12 months.

While I don't reccomend ever buying a stock you see advertised, its good to know what's being hyped. It is worthwhile in my opinion to check out Websites and such that promote "Sure Winners", "5 Stocks You Have to Own" and the like...but not for buying purposes, rather as an avoidance technique. You might think you're missing some gainers, but the idea here is to avoid ending up as a bag holder, and when stocks are in the process of being hyped there's a very good chance of that.

Buying In
Once you have identified a thinly trading stock, one that hasn’t been promoted for a long time, with a large quantity of authorized but not yet outstanding shares…now comes the hard part, buying in. I will strongly suggest that you don’t get greedy, because no method, (no matter how good) is 100% full proof. In my opinion no more than a few hundred dollars should be risked on any one stock, and only if you can afford to lose it all. The best method in my opinion is to pick 3 or 4 stocks that fit this profile because you may be waiting a while for the pump to happen.

Another reason not to get greedy is because you’ll be buying shares through a Market Maker Broker Dealer, commonly referred to as an MM. Penny stocks that are trading very light volume are often tightly held, that is to say ‘the float’ isn’t actively trading. MMs still have to make a market for the stock which means when a buy comes in they may very well be forced to go short in order to fill an order.

MMs are in business to make money for themselves, not for individual traders. Don’t be surprised to see a stock you just bought suddenly become very volatile. This is sometimes referred to as ‘shaking the tree’. Market Makers are well aware of the fine art of psychology and they know penny stock players are both greedy and nervous. Your order might be filled in a nanosecond, in an effort to have you think, ‘shit that was too easy’. Delayed fills with stocks being pumped by contrast are fairly common, making the trader think MMs are short and don’t want to sell.

Hold And Wait For The Pump – AND SHUT UP
I can’t emphasize this enough, as this was an area I was not disciplined enough about. Once you have your stock or stocks, sit back and wait and AVOID MESSAGE BOARDS!!! If you’ve chosen well the boards for your stocks are going to be either dead or subject to heavy bashing. Tuck your ego in your back pocket and watch but don’t say anything. If you start trying to hype the stock or to argue with bashers you’re only giving aid to the enemy. Industry hacks work the boards much harder than individual traders so don’t give them any ammunition. If the stock(s) you’ve chosen is due to be pumped it will happen on their timetable, not your’s. Try to pump it all you want, but its the MMs who set the bid/ask...not you.

Sell Into The Pump
Now the hardest part, selling. I’m not going to suggest a percentage or a specific amount. Obviously you’ll need to cover your trading costs, both in and out…and the realization of a decent profit. Once you determine what that figure is, stick to it. Check out the charts for otcbb volume leaders to get a feel for a reasonable profit and take it. And if the stock keeps going higher, oh well, too bad so sad, take your money and move on. If the stock keeps moving higher then chances are there are MMs with inventory (shares) they’re looking to dump. Industry types like MMs know that traders plying their trade in penny stocks hate seeing a stock they’ve sold for a dime keep climbing to a quarter or 50 cents. Realize this though, you’ll never lose money by taking profits and if you buy back in you’ll run the risk of being left holding the bag.

The Games MMs Play
When an industry player has a large volume of shares he/she wants to dump into the market, they don’t do it sitting at their desktop hitting the sell button. They hire a professional, a Market Maker Broker Dealer. The U.S. Department of Justice has investigated numerous cases of manipulation, one of which is called a “Move on Request”. Basically it involves two MMs working in concert, with one asking another to move the bid/ask up or down on a particular stock depending on which way he needs the price to move. It’s a "quid pro quo" system where MMs scratch each other’s backs, because the MM making the request will probably be asked later to help out another MM when he has a stock he needs manipulated. Push it up when long, take it down when short...not something an individual trader has the power to do.

Looking at it from the perspective of industry insiders here's the game:

1) Lock up as many of the outstanding shares as possible (the float).
2) Engage the services of MMs to dump authorized shares into the market.
3) Hire promotional outfits and toutsheets to talk up your stock.
4) Sit back and hope the MMs and touts do their job well, maximizing your profits.

So there you have it, a system I believe is superior to most being punted by industry hacks and insiders. They want buyers for the stocks that are “in play”, in other words the ones that are being promoted and making them $.


For the DOJ article on “Moves On Request”

OTCBB Website for Volume and Authorized vs Outstanding share counts. For share counts (authorized and outstanding) type in the ticker symbol in the box at top left, then look at the top right of the page under “Related Items” and pick Company Profile:

I hope you enjoyed reading my blog and I welcome your comments, I read them all. If you think this piece would be of interest to anyone you’re most welcome to pass it along via email or through a social network like FaceBook, just click on the ‘Share This’ icon below.

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