Last Updated on 10 February, 2024 by Rejaul Karim
Trading penny stocks can be risky, considering their illiquid and volatile nature. Plus, they are susceptible to pump and dump schemes and other scam practices. However, a penny stock can be greatly rewarding for a bargain hunter. So, you may be wondering if you can swing trade penny stocks
Yes, you can swing trade penny stocks if you know what you are doing. The attribute that makes most traders shy away from penny stocks is the same that qualify them for swing trading — volatility. The sharp movements of penny stocks present excellent entry and exit points which a diligent swing trader can exploit by riding the short-term trends.
I guess you would want to know how to swing trade penny stocks. So, let’s dive in! In this post, we will discuss the following:
- What swing trading is
- What you should know about penny stocks
- Why you can swing trade penny stocks
- The right approach to swing trading penny stocks
- Strategies for swing trading penny stocks
- Four mistakes beginners make when swing trading penny stocks
- Tips penny stocks swing traders should adhere to
What is swing trading?
Swing trading is a speculating trading style that tries to benefit from medium-term price movements, which are normally the price swings we see on the daily timeframe. This style of trading lies in the middle of the spectrum between day trading and buy-and-hold investing. The key difference is the holding period.
Swing traders seek to capitalize on the upward and downward “swings” in the price of a security within a larger overall trend. However, experienced swing traders do not aim to score big with one trade, but hope to register lots of small wins that add up to significant returns in the long term. For example, while a buy-and-hold investor may wait six months (or even a year) to earn a 25% profit on his portfolio, swing traders may earn 5% gains weekly and exceed the other trader’s gains in the long run.
The idea behind swing trading is to capture the individual price swings on the daily timeframe, rather than ride the full trend with the multiple up and down swings. Hence, the key is to identify the beginning of a new price swing, especially the impulse swing in the direction of the trend, and enter a trade to ride that swing to its completion but, then, hop out of the trade or switch direction when the opposite swing starts.
Swing traders are a lot like day traders, but there is a significant difference between both types of traders. Firstly, the timeframes differ for both trading styles. While day traders do not hold their position overnight, a swing trader can hold his position for weeks. Day traders can be in and out of trades within minutes or hours, but swing trading generally lasts days or weeks.
In essence, swing traders are not much bothered about the intraday price fluctuations that arise from news announcements. However, their positions can be affected by overnight gaps that may arise from any severe price movements following events that occur at night or over the weekends.
What you should know about penny stocks
In the U.S. market, penny stocks are securities that trade below $5, but in the U.K. market, they are stocks that trade below £1. These shares are of new companies or those with low market capitalization. Penny stocks may also be shares of companies that were originally robust, but which have performed very poorly in recent years.
Penny stocks can be traded through exchanges, but most are traded on the over-the-counter market, also known as the Pink Sheets in the United States. Though penny stocks are cheap, their trading volume can be quite low, which affects liquidity. As such, the bid-ask spreads of penny stocks tend to be wider than those of stocks of bigger companies.
Another problem with low liquidity is that traders may not find a buyer when they want to sell their stocks, so trading at a stipulated price target becomes a problem. Also, the stock prices can be highly volatile. Because they are cheap, have low liquidity, and do not attract much attention and scrutiny from the regulators, penny stocks are susceptible to manipulations.
If you are new to stock trading, it is not advisable to trade penny stocks. The odds of blowing your trading account are far higher than hitting a home run. Yet, despite this, some traders are able to squeeze considerable profits from swing trading penny stocks.
Why you can swing trade penny stocks
While it is not advisable for a new trader to trade penny stocks, experienced traders can try their hands on penny stocks if they choose to. Penny stocks are best suited for short-term trading, including swing trading. These are some of the reasons why you can swing trade penny stocks:
- Volatility: Penny stocks are very volatile and can make their moves in a matter of hours or a few days. It is quite common for a penny stock to make 50% or even 100% moves in a few trading days, which is why it is best suited for day trading and swing trading. Thus, the high volatility in penny stocks can be a good advantage to a swing trader who knows how to do it.
- Easy to access: There are online discount brokers that offer access to trading penny stocks. Some of them include Interactive Brokers, TD Ameritrade, Charles Schwab, and Fidelity. Brokers like TD Ameritrade and E-Trade make it possible for a trader can set up an account with a small deposit and start trading penny stocks. So, penny stocks are easily accessible to traders with small accounts. A swing trader doesn’t need a big capital to start trading the stocks. With a few thousand — or even a few hundred — dollars, a trader can buy thousands and millions of shares in these stocks, which is not possible with higher-priced stocks.
- Low prices: One of the main benefits of penny stocks is that they trade at very low prices. Normally, the SEC uses the $5 mark to define them, but the truth is that many of them trade at pennies per share. So, a trader with a small trading capital can buy a lot of shares of penny stocks at a time.
- Potential for huge returns: Penny stocks have the potential to generate huge profits. Because penny stocks are trading at low prices, if things turn out right and the stock you bought moves favorably, it can get to double, triple, or even more, of the price you paid for it in just a few days. The profit can be very huge.
However, to successfully swing trade penny stocks, there are things you need to know.
The right approach to swing trading penny stocks
There are two approaches to trading stocks — fundamental and technical analysis. Swing traders that use fundamental analysis base their trading decisions on the company’s financial performance, so they examine the company’s balance sheet, income statement, and profit and loss statement, especially following an earnings report.
On the other hand, those who depend on technical analysis make use of charts and study the direction of trend and position of support and resistance levels. Traders who make their trading decisions based on technical analysis don’t bother with the company’s financial performance.
When it comes to swing trading penny stocks, it is best you use the technical analysis approach rather than fundamentals. The volatile nature of penny stocks means that the stock could experience sharp price movement without any fundamental factor behind the move. Moreover, because penny stocks attract less attention from most investors and analysts, their fundamentals don’t get discussed, and it is difficult to determine their intrinsic values. So the prices of penny stocks are rarely dependent on fundamental factors.
Strategies for swing trading penny stocks
Penny stocks are a unique kind of stocks; not many strategies can work with penny stocks. There are only a few strategies you can use for swing trading penny stocks, and these are some of them:
- Momentum: The momentum strategy, also known as the trend-following strategy, aims to trade in the direction of the trend after a temporary pullback in price movement. The idea is to trade the impulse wave in the direction of the trend and hop out when a pullback starts, which can erase the profits. To use this strategy to swing trade penny stocks, you must have a good knowledge of how support and resistance levels work because those are the places to look for trade setups. Penny stocks don’t usually have long-term trends; rather, they make random walks to either direction depending on where the momentum lies. However, some key support and resistance levels are still respected, so when the price bounces off a key level, consider placing a trade.
- Buy the rumor and sell the new: One popular strategy for trading penny stocks is to buy the rumor and sell the news. With this strategy, you are trying not to be a victim of pump and dump schemes but, rather, benefit from them. When the news is out there, the organizers of the scheme are already pulling out from the market, so you should be sell as well.
To learn more robust swing trading strategies, you can enroll in a good swing trading course that can teach you how to select the right stocks to trade and how to identify profitable trading opportunities.
Four mistakes beginners make when swing trading penny stocks
Mistakes are common in trading, but they are even more common when swing trading penny stocks. Anyone can make these mistakes, but beginners are more liable to get caught up in them. Here are the four common mistakes beginners make when swing trading.
1. Not starting small
Some novice traders do think that stocks only go up. Unfortunately, they get to learn the hard way. Penny stocks post more declines than rallies. When swing trading penny stocks, the odds are stacked against the trader. Going all in would only complicate matters because now the stakes are high and can lead to making hasty decisions that result in losses. It is always better to start with a small percentage of your trading capital.
2. No trading plan
Swing trading without a plan is like driving without headlights on. This risk is amplified when trading volatile assets, such as penny stocks. There has to be a well-detailed plan specifying entry and exit points. This should be backed up with stop losses and take-profit targets.
Swing trading comes with the temptation to overtrade. This has been exacerbated by the proliferation of commission-free trading apps which allow traders to post as many trades as possible in one day. Overtrading is a sign of lack of control and trading strategy, and it only leaves a hole in your pocket.
4. Hanging on to losing trades
There is no need to hang on to a losing trade; penny stocks are more likely to keep declining than turn back in your favor. But out of fear or greed, swing traders may refuse to cut their losses and hold on to a stock. This can only lead to more losses and more importantly, tie up capital that can be used to make a new trade that may even be more profitable. The best rule in trading, especially trading penny stocks is to cut your losses quickly according to your trading plan.
Some of the tips a penny stock swing trader should know
Here are some tips that can help you when swing trading penny stocks:
1. Avoid OTC/Pink Sheet-listed penny stocks
Penny stocks that are traded over-the-counter are not well regulated like those listed on exchanges. As such, they are more susceptible to dubious trading practices such as price manipulation and pump and dump schemes.
2. Avoid promotional/meme stocks
Some companies pay for their stocks to be promoted on social media so as to push the prices up. This practice is quite common among penny stocks. You may think that you have discovered the next Tesla or Apple, without knowing that it’s the work of promoters trying to sell miserable stocks to you. As a rule, when trying to swing trade penny stocks, avoid stocks that appear to be promoted on social media.
3. Do not trade penny stocks with low volume
Without liquidity, it would be difficult to trade penny stocks profitably. Liquidity determines the bid/ask spreads on a stock, which in turn affects the buy-sell price, as well as your ability to close your trade whenever you want. If a penny stock is illiquid, it is best to avoid it because you may not see other interested parties to deal with when you want to exit your position.
4. The hit and run approach
Swing trading is profitable when you use the hit and run approach. This means trading for a short period at a time and accumulating small gains from each trade. This reduces the risk that comes with holding your positions for too long. Make use of profit targets so that once they are hit, you exit from your trades.
5. Trade one-day at a time
Always meet each new trade with a fresh mind and perspective. While you can rely on historical data, you should know that every situation in the market is unique. So, trade your setups as they come and accept whatever outcome that follows.
6. Look for trends and patterns
The trend is your friend, but penny stocks don’t often show any trend. So, you may have to depend on patterns and volumes as the compass to navigate the market. They tell you when to enter a trade and when to plan your exit.
7. Watch out for pump and dump schemes
Penny stocks are well known for pump and dump schemes. However, if you pay attention to your charts and trading volumes you would be able to spot one from afar off. The rule is to buy the rumor and sell the news.
8. Cut losses quickly
Risk management is the hallmark of successful swing trading, so you need to have a robust risk management strategy when swing trading penny stocks. While you never really make a loss until you sell, you have to know when to call it quits and exit an unprofitable position. Since penny stocks can experience sudden sharp price movements, you need to make use of stop loss orders to cut your losses quickly. Note that since the penny stocks are often illiquid, you may still have some slippages.
Do your own research
While you may focus on technical analysis when swing trading penny stocks, you need to do some research to select the stocks you trade. The better the fundamentals, the more likely the stock will make a good trade.
Swing trading penny stocks is not for the faint hearted. It requires high risk tolerance along with the ability to react quickly to market swings. However, if you believe that you have the skills to swing trade penny stocks, create a simple strategy for identifying good trading opportunities. While you use technical analysis to identify trade setups, you may need some fundamental analysis to select the right penny stocks to swing trade. If the process appears cumbersome, you can subscribe to a swing trading signal that tells you the stocks to buy and when to buy them.
What are penny stocks, and how are they defined in the U.S. and U.K. markets?
Penny stocks in the U.S. are securities trading below $5, while in the U.K., they are stocks trading below £1. These stocks typically belong to new or low-market-cap companies, and they may also include shares of previously robust companies that have underperformed.
Why are penny stocks considered risky for new traders?
Penny stocks can be traded on exchanges, but most are traded over-the-counter, such as on the Pink Sheets in the U.S. Low liquidity is common due to their low trading volumes, leading to wider bid-ask spreads compared to larger company stocks. Penny stocks are risky for new traders due to their low liquidity, susceptibility to manipulation, and high volatility. The odds of losing the trading account are higher for new traders compared to making significant profits.
Why is technical analysis preferred over fundamental analysis for swing trading penny stocks?
Technical analysis is preferred for swing trading penny stocks because their volatile nature can lead to sharp price movements without significant fundamental factors. Additionally, penny stocks attract less attention, making it challenging to assess their intrinsic values.