Ever see a penny stock go up over 30%, want in, but don’t want to chase? Well, it happened to me a lot when I first started out trading. There were even some times I would chase the stock up, only for it to pullback. This is a common problem when people are learning how to trade penny stocks. You could actually learn how to buy penny stocks without having to chase it up more than 50%. Why own a penny stock that ran from $3 to $4, when you can wait for the pullback and get it cheaper, anticipating a second leg up?
What Is a Pullback in Stocks?
A brief reversal in a price action of a commodity or stock that lasts for a few consecutive sessions is called a pullback.
How to Buy Penny Stocks – The Pullback
Traders in the community watch for this all the time. They wait for a high-flying penny stock to pull back, buy some, participating in the potential move higher. Now, you do need to learn a little bit about the Fibonacci retracement to do this properly.
The Fibonacci Retracement
The Fibonacci retracement is widely used by technical traders. Without getting into all the math, it’s based on the key numbers in the Fibonacci ratios. When we use the Fibonacci retracement to buy penny stocks, it allows us to buy them at specific prices and ranges. In turn, it’s easier to develop a trading plan, which is highly crucial when you’re learning how to buy penny stocks.
To use the Fibonacci retracement, you need to spot two extreme points. A lot of the times, I’ll use the swing low and swing high, especially if the penny stock had an explosive move within a few trading days. When we’re looking at stock charts, the Fibonacci is typically calculated on nearly any free charting software and maybe your trading platform. The key ratios you should focus on are 23.6%, 38.2%, 50%, 61.8% and 100%.
When you define those ratios, you’re able to potentially spot key support and resistance levels. In other words, you could spot points where there may be buyers and sellers, respectively.
Let’s move onto some examples and see this in action.
How to Trade Penny Stocks – Fibonacci Retracement Example
For example, we saw NNDM have a big run up. From the $1.35 – $1.40 area all the way up to $3.35. We’re always looking for stocks like this. Let’s take a quick look at how you can do this easily with zero cost.
If you go to Finviz, you could just go under the “Screener” tab. First, we’re focused on stocks under $5. A penny stock doesn’t need to be trading at pennies per share to be considered a “penny stock”. According to the U.S. Securities and Exchange Commission, a penny stock is just simply a stock trading under $5.
Next, we want to look at penny stocks with an average daily volume of over 1M shares. Moreover, we want to see the stock have an explosive move, so we’ll look at those that moved over 20%. You can go under the “Technical” tab when you’re on the screener page and select “Up 20%” on the “Change” dropdown.
You should see something like this:
Keep in mind, there are some days that no stocks will be on this filter.
This is how we spotted NNDM. Now, here’s a look at the chart I was looking at.
Notice how the stock found some support around $2.11, or the 61.8% Fibonacci retracement level. All I did was use the tool to connect the swing low to swing higher. Thereafter, the charting software does all the work.
I waited for the stock to actually catch a bounce and retrace before I bought the penny stock.
Although I was looking for a move to $3, sometimes you just have to keep your expectations in check and take the profit.
The Bottom Line
When you’re learning how to buy penny stocks, you shouldn’t chase them when they’re up over 20%. Rather, you should wait for the pullback. Now, it’s not hard when you learn how to use the Fibonacci retracement tool. It’s going to take you a lot of practice, but over time you should be able to learn how to spot support and resistance.
Jason Bond runs JasonBondTraining.com and is a swing trader of small-cap stocks.