Hype! - Phases in the Life of a Penny Stock Promotion There is only one thing that drives the price of a penny stock - promotion. Whether a company is mining for gold, developing Internet software or marketing an invention that will solve the energy crisis, a stock needs the marketing acumen of Madison Avenue and the ethics of a used car salesman. In the process, the market will see some amazing examples of both. There are a number of phases in the cycle of penny stock promotion. Technical analysis is an excellent way to recognize and track these phases. Consider the following:
A. Accumulation
In the initial stages of the run-up, the promotion needs to build its foundation. Typically, firms engage professional promoters to hype their stock using personal contacts, media and pro traders. In this stage, the stock may be quite illiquid and there are occasional large blocks of shares traded as insiders are given their shares at low prices. News announcements issued by the company will often concern the issuance of incentive options to insiders and numerous private placements. In addition, companies are seeking deals that will later be the base of "the story".
B. Potential Building
The company needs a good story with huge upside potential. In this stage the rumour mill starts to churn out the promise that will later drive the stock price. The stock will have brief but potentially profitable upturns in stock price based solely on the potential that the firms' story affords. The stock is volatile and there is some selloff by insiders at market tops. Following the price spike, insiders buy back their shares as the short term hype cools. However, the promotion is not yet in full swing.
C. The Breakout
At some point, the story has to come to a climax. This begins with the breakout from a trading range and increase in volume. The number of market participants goes up, the stock may be featured in a number of media sources and "great stock tips" begin to really circulate. Meanwhile, the company is nearing the decisive point where it will either become a legitimate company or failed attempt. Stock price is based primarily on expectations and not facts.
D. Profit Taking
Those who have held shares through Phases A and B may sell their shares and take profits. This causes a short down trend and sceptics often dump their shares for fear of a big loss. It is critical that the stock stabilize above some level of technical support if it is to continue appreciation.
E. Euphoria
The stock resumes its upward trend and volumes move to extreme levels. The promise of overnight fortunes begins to bring new money into the stock. Fewer pro traders and more small investors move into the stock. Trade sizes go down and number of trades goes up. The stock goes far beyond intrinsic value and trading becomes euphoric. The stock is teetering over a cliff as insiders rapidly dump their shares into the huge demand.
F. The Short
Pro traders begin shorting the stock on the up-tick. Volume is still very high but the price appreciation is slowing. The stock has difficulty closing near the high of the daily trading range. The stories are still good which convinces the small investor to continue buying. As the shorts build their book, rumours begin to circulate that the company is running into problems. Fear begins to replace greed. Soon, it's BBUUNNGGEE.
G. Dead Cat Bounce
Bargain hunters who still believe in the story buy back shares at low levels, foolishly missing the point. The insiders dumped their shares early and now are answering regulators' concerns about why they failed to file insider trading reports. Shorts cover their positions which causes the short term spike in volume.
H. Reality Check
The stock resumes its downward trend as small investors get the education that they have paid for. They learn what a "short" is, that "grab samples" don't really mean anything, that management does not have the integrity that they thought and that the best story in the world does not mean anything when it is told by a con man. The insiders take a brief holiday in the Cayman's and then start another promotion. Remember: The market is governed by two things; fear and greed. Let the market tell you what to do and never fight the trend.
When to Sell
The most difficult part of trading penny stocks is knowing when to sell. Pin-pointing stocks that are poised to make explosive gains is really quite simple but, although the theory is similar, selling requires much more attention and analysis. Strong promotions will cause the price to escalate very quickly but in almost all promotions, reality sets in at some point and the stock price comes crashing back down to earth. Because the crash can be so profound, it is often very difficult to get out of the stock in a timely manner after the crash has started. The challenge, then, is to get out of the stock just before the crash and maximize profits.
What adds difficulty to this procedure is that, during even the strongest promotions, there is a propensity for market participants to take profits. This can cause temporary stalls in the price escalation and send nervous participants running scared. However, profit taking incited stalls are usually just blips in the upward price move and will cause lost potential profits to speculators who sell. At the same time, we want to know when the 'reality check' is starting so that we can get out and preserve the profit we have gained.