Selecting the Best Penny Stocks for Your Day Trading Strategy

Selecting the Best Penny Stocks for Your Day Trading Strategy

penny_stock

Russel 3000 index which tracks small stocks

As a day trader, your goal is to always search for alpha. This alpha can be derived from trading different instruments which include: ETFs, currencies, commodities, indices, and equities among others. With thousands of instruments available today, getting the right one is relatively tough. Thousands of investors have made billions trading all these instruments using different strategies. Warren Buffet has made billions of dollars by buying good companies and holding them for years. George Soros on the other hand has made billions by being an active trader. William Ackman has made billions by being an activist investor while a good part of David Einhorn’s portfolio is in currency trading.

While many people prefer buying large companies such as Apple, a good group of them prefer buying small companies with less than $30 million in market capitalization. The advantage of investing in these small companies is that their share prices is often less than $5. This gives the investor a good platform to buy more shares and make more money with minimal price movements. For instance, on Thursday, a small cap company called Five Prime Therapeutics went up by 65.17%. Affirmed N.V went up by 24.27%. On the other hand, Imprivata Inc. lost more than 30%. This shows the nature of volatility in the small caps space.

Investing in these companies is also one of the riskiest undertaking one can make. This is attributed to a number of reasons. One, some of these companies are usually very small and probably have a history of bad management. Second, some of these companies have poor debt to equity ratios making them susceptible to bankruptcy. Lastly, some of these companies have a serious liquidity problem.

Activist actions

As a day trader, you want to make money without owning these companies. Having a long term view of the small cap stocks is a very risky thing unless you have some inside information of a future acquisition. This is simply because of the fact that the longevity of most small caps is usually at risk.

There are other scenarios when some small cap companies are very well making them targets to activist investors.

Activist investors are hedge fund managers who take a small ownership of a company. After owning the company, they start introducing new changes to the company’s leadership. In most cases, they set the business for acquisitions.

Once an activist investor announces a stake in any company, the company’s shares respond by going up. For instance, when activist Carl Icahn announced a stake in Apple, the shares of the company went up by more than 30%. In addition, when William Ackman announced a stake at food manufacturer, Mondelez, the shares of the company responded by going up by more than 15%. On the other hand, when an activist announces a short position in a company, it usually responds by going down.

As a day trader it is important to follow all the major activist investors and know what they are up to. By having a good understanding of what an investor is doing, it will give you a chance to understand what they are buying and selling.

News releases

All public companies are mandated by law to issue press releases on their earnings. They are also required to issue forecasts of how their businesses are doing. As a trader, the earnings season should be your most interesting time because of the opportunity to make money during small movements.

Most of the small caps companies issue financial statement without much fanfare. This is mainly because the major financial media does not follow these small companies. Large investors too are mainly not interested in such small companies.

As a day trader, this is where you need to capitalize on. By following a select group of small cap stocks, you will be at an opportunity to make more money during the earning season. I recommend that you follow less than 15 companies. This will give you an opportunity to learn and understand their operations and how they make money.

While trading small caps stocks can be very profitable, a lot of care should be taken. According to data from Bloomberg, hundreds of small caps stock go bankrupt annually. As a result, many traders and investors lose a lot of money. Therefore, it is important for you to take time and do the necessary research before you make any investment. Also, your capital invested in small caps should be minimal because of the risks involved.