Ignoring This Crucial Indicator Turns Winners into Losers
Dear Penny Stock Millionaire,
Have you ever locked yourself out of the house or your apartment? Sucks, doesn’t it? No keys, so you can’t get back in. Then you have to call the locksmith or the manager…
How about trying to sell something you no longer want on eBay? Like some exercise contraption you never used. It’s collected dust for the last two years and you just want to unload it for a reasonable price. But nobody is buying…
Trying to trade illiquid stocks is kinda like that. You want to get in or out of a play but you can’t because there’s not enough trading volume. The penny stocks I trade have two basic requirements…
This isn’t rocket science. There aren’t a thousand different things you have to know. There aren’t a thousand different patterns or catalysts. There aren’t a thousand different requirements for finding the right stocks to trade. There are only a few.
But you have to learn to recognize the patterns, catalysts, characteristics — all the things you do need to know. It takes studying.
OK, rant over. Back to volatility and liquidity.
Volatility is big price action. Swings. Movement. As a penny stock trader, volatility is your friend. So is liquidity, which is what this post is all about.
What Are Liquid Stocks?
As a day trader, I specifically look for liquidity when I’m considering a play. What are liquid stocks? Liquid stocks have enough trading volume that you can enter or exit a trading position without too much trouble. There are buyers and sellers making plays.
For a day trader, there’s not much worse than holding a 10,000 share position and watching the whole trade implode because you can’t buy or sell. Illiquid stocks don’t have enough trading volume to be a good opportunity. Plain and simple.
Benefits of Trading Liquid Stocks
One of the most important things I teach my students is risk management. Your risk management strategy shouldn’t be an afterthought. That’s a fast way to disaster. Believe it or not, risk management is probably the number-one benefit of trading liquid stocks.
Day trading involves timing your plays with fast-moving prices. Penny stocks — the ones I trade — are volatile. Liquid stocks let me open and close positions quickly and stay within my risk management strategy.
Here’s a blunt fact about trading penny stocks: Most penny stocks are not liquid.
It’s one of the built-in cons — as in pros and cons — of trading penny stocks. That’s why I want you to understand how to find liquid stocks before you risk your hard-earned money.
If you already trade penny stocks you know it might take a little longer to execute an order. It’s not like trading Microsoft (MSFT) — where your buy or sell order is going to get executed almost instantly. It’s a built-in feature of trading penny stocks that orders take a little longer to execute.
“But Tim, why would I want to trade stocks that take longer to execute? Isn’t that risky?”
That’s why I teach risk-to-reward ratio and risk management. In my opinion, hoping your shares in some giant corporation are going to make you rich before you retire is real financial risk! Here’s the deal…
I recommend you look into penny stocks that trade in the 200,000–5 million shares per day range. They’re liquid but not the most active. Penny stocks that trade in the 50 million plus range are liquid but too choppy for me. I tend to get scared out of the trade.
Also, understand the market can shift. Last month’s supernova might have already fizzled out. What’s in play this week might not be in play next week. Trading strategies change based on what’s really going on in the market.
There’s a lot less competition trading penny stocks. Plus, as long as you know beforehand that you need to find stocks with good liquidity, you’re one-up on the competition. Seriously.
Most people buy these stocks because promoters hype them to their email list. Maybe the company thinks they have the next big thing so they put out a press release. Let me tell you a secret: almost all those companies are going to fail. Don’t think you’re getting in on a MSFT at the beginning. You’re not.
You’re here to learn how to trade and you want the best chance to be successful.
Here’s a big-picture reason to be a fan of liquidity: Imagine what would happen if there wasn’t a liquid stock market. If it was difficult to buy and sell shares, the markets would grind to a halt. It would affect investment in business. Who wants to invest in a company only to be told you can’t get out of the investment?
Does this make sense? The secondary market for company shares and other types of securities is what makes investing in a company attractive. The secondary market is what you and I are trading. A liquid stock market is what makes it possible.
Back to liquidity in penny stocks…
Why Is Liquidity Important While Determining Entry/Exit Indicators
Knowing your entry and exit points will help you determine whether a trade fits your risk management strategy. Ultimately, it determines the success or failure of your trade.
No matter how well you plan, not every trade is going to work out in your favor. Hell, even I only win about 70% of the time. If you do your homework and create a plan for your trade, you’ll have targets for when to open and close your position.
Plan? What plan? If you follow what I teach, you’ll have the trade ready to execute beforehand. And not only the entry and exit points. You’ll know what pattern you’re trading, the reason or catalyst, how much you’re willing to lose should the trade turn against you (risk vs reward) …
This isn’t gambling. It’s a skill. Remember that. Ok, say you’re ready to make your play. You’ve studied and you have your plan …
All good, right? But what if you missed the mark on liquidity? What if trading volume sucks or there’s some sort of slowdown — for whatever reason? You could have everything worked out and then not be able to get in our out of your trade and end up completely screwed.
In your plan, it’s called ease of entry and exit. Entries and exits rely on timing. Liquidity has an effect on timing. Remember, orders take time to execute. You want to be in and out of your positions as close as possible to your targets.
When building my watchlist I have a few requirements. I’m looking for penny stocks that are:
- Highly volatile
- Highly liquid
- Then I’m looking for big price moves, and a catalyst that makes sense, like news or an earnings release.
For liquidity, you want to keep an eye on trading volume. Don’t mess around with illiquid stocks — they’ll bite you in the ass.
What’s my number one rule? If you’ve been reading my blog for a while you should know this. If not, make it a mantra: cut losses quickly. Liquidity makes this possible. Of course, you still have to act on it. Trade-chasing is a bad idea, but if the stock is highly liquid at least you can close your position. Win or lose.
The Bottom Line
If you want to be a profitable trader, liquidity is one of the key things you need to include in your research before you buy a stock.
Even if everything else with the trade looks perfect, highly volatile, technical analysis checks out, reasonable catalyst, without liquidity is just a money trap. If you’re looking to make a trade and it’s illiquid, it just means that you’re stuck in a trade and won’t be able to exit when you want to take your profits. If you can’t exit when you need to, those profits could turn very quickly into huge losses.
So before you buy, make sure you’re not locking yourself into a trade you can’t get out of. Tomorrow I’ll explain how to identify great liquid stocks you can trade.
Editor, Penny Stock Millionaires