There are a lot of indicators out there, and I’ve narrowed them down to a few over my years of trading penny stocks. Basically, I’ll use the Moving Average Convergence Divergence (MACD) indicator coupled with the Relative Strength Index (RSI), Average True Range (ATR), volume, moving averages and chart patterns. If you’re just starting to learn how to trade penny stocks, it’s a good idea to start in bite-sized chunks. That way, you won’t have information overload. The RSI indicator is great if you’re trying to figure out whether a penny stock is overbought or oversold. That said, let’s take a look at how to use the RSI to trade penny stocks.
Trading Penny Stocks Using RSI
The Relative Strength Index (RSI) is a momentum indicator that gauges the magnitude and speed of recent changes in price. It’s used to identify overbought or oversold penny stocks. That’s why this indicator is extremely powerful when trading penny stocks.
You’ve probably seen a penny stock explode, only to pull back due to profit takers and short sellers. Well, what if you thought the stock was still a buy, but didn’t know when to start buying shares of the penny stocks? This is where the RSI comes in. Now, you should know that I don’t solely use the RSI to get into penny stocks. Again, I’ll look at other indicators and patterns. Before you start combining indicators, you need to understand how to use them to trade penny stocks.
Getting back. The RSI gives you an idea how strong a stock’s recent price performance. When you’re looking at the RSI, if the line is above 70, it indicates the penny stock may be overbought. On the other hand, if, the line is below 30, it indicates the penny stock is oversold. It’s simple and easy-to-use when you’re trading penny stocks.
Again, this does not necessarily mean a stock can’t go higher if it’s above the 70 level. Conversely, if the RSI is below the 30 level, it doesn’t necessarily mean the penny stock can’t go lower.
That in mind, let’s take a look at some examples.
Trading Penny Stocks Using RSI – Example
For example, take a look at Revolution Lighting Technologies (RVLT).
If you just look at the chart, you might think, “Wow that stock dropped over 50% from its recent high in just a month. It must be oversold!”
Well, it doesn’t always work out like that. You have to use specific indicators, such as the RSI, to give you an idea whether a stock is actually oversold.
Well, if you look at the RSI, it’s below 30. Remember what we said earlier about the RSI? Oversold penny stocks are when RSI is below 30 and overbought when it’s above 70. That said, you can clearly see the RSI is at 14.62, well below 30.
Again, keep in mind, just because the RSI is below 30, it does not mean the stock can’t go lower. This is key when you’re looking to buy penny stocks for a potential reversal. I learned this the hard way when I was first starting out to trade. Over time, you’ll learn how to trade penny stocks using the RSI and other indicators with some time and effort.
Make sure you use risk management tools and use other indicators to potentially increase the probability of trade.
Now, I actually traded this stock and had a trading plan.
I waited for the penny stock to form a base before I bought shares. I had a target in mind and proper stops in place.
Here’s a look at where I actually bought the stock (it’s where the horizontal and vertical line intersect).
The stock caught a pop the next day, and I ended up taking profits.
Once I hit my profit target, I ended up selling the stock because it already worked. I’m fine with taking profits and letting stock go up without me. Sometimes it’s not worth the risk to hold onto a stock that’s clearly in a downtrend.
The Bottom Line
The RSI could be helpful when you’re trading penny stocks. One crucial note: just because the RSI is at extreme levels, it doesn’t mean the stock can’t continue higher or lower. Now, you’ll need proper risk management tools, and you might want to consider using this indicator with the MACD and some chart patterns.
Jason Bond runs JasonBondTraining.com and is a swing trader of small-cap stocks.