Chapter 2 – Stock picking
Revised: March 14th, 2019 V1.0
How to lose money when trading
Introduction
The idea of these articles is not to make you the ultimate trading machine. Only a few are and will
ever be. The idea and intention here is to help you avoid the most common mistakes that either
make you lose some or all of your savings. In worst case trading may put you in debt. Becoming a
winner is very much like evolution in nature - you learn from your mistakes. The stock market is full
of predators just waiting for newbies they can feed on. Stocks may be subject to “pump and dump”
where news is pushed to press the stock up while major players sell, or the other way around.
Another common way is for professional traders to fire up a rally in illiquid stocks and let small
traders lose as they get in too late and get out even later. These events are known as “the penny
stock runs” as they mainly happen in penny stocks with very low daily trading. These runs are often
initiated by stock forums spamming where the initiators of the run pump rumors or otherwise create
attention to the stock just after buying shares. However, the main reason so many investors lose
money while trading is due to lack of knowledge and access to information.
I will bit by bit introduce technical analysis in this text as I believe this is a tool any trader should
know. Technical Analysis (TA) will help improve your timing and ultimately help you make better
overall trading decisions. In the end, it all comes down to decisions, and in the stock market, there is
very little room for error unless you have proper stop-loss strategies.
Yours,
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Table of Contents
Chapter 2 – Stock picking ........................................................................................................................ 4
The many conditions ........................................................................................................................... 4
Which stock to pick?............................................................................................................................ 5
Defining a strategy - the start.......................................................................................................... 5
Define your strategy - Knowing your fundamentals, part I. ................................................................ 9
Adding more elements to your strategy ....................................................................................... 11
Define your strategy - Knowing your fundamentals, part II .............................................................. 12
Define your strategy - Knowing your fundamentals, part III ............................................................. 15
Include fundamentals in your strategy ......................................................................................... 17
Define your strategy - Before we move on ....................................................................................... 18
Learn to evaluate your actions ...................................................................................................... 18
Information will try to fool you ..................................................................................................... 18
Pump & Dump ............................................................................................................................... 19
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Chapter 2 – Stock picking
The many conditions
I hate the word random. It includes too much uncertainty for me. But the fact is, that in a very strong
bull market you can just do a random choice and in many cases, be better off than listening to a
professional. In strong bull markets, the professionals usually underperform compared to the index.
The main reason for this is that working with strategies naturally involve an element of risk reduction
while stocks in bull markets often behave in irrational ways. In bear markets, however, the situation is
totally different. You will need both skills and luck and then the natural element of risk reduction in
strategies become your true friend. There is a reason why some of the most famous expressions are:
“let the trend be your friend”, “if it sounds too good…” and “whatever goes up, must at some point
come down”.
One of the most basic things you need to learn is to define your starting point. It is just like driving, it
is easier to navigate if you know where you are. In stock trading, the starting point refers to the state
of the market and the state of the stock you plan to buy or sell. And this is where things start to get a
bit more complicated, because these conditions change by the day, even by the minute. To complicate
it, even more, your picking strategy should be based on several more factors which are also constantly
changing. Luckily there are several tools available to help you in these matters, stuff like technical
analysis, fundamental analysis, market reports, financial news, and stock forums. Your challenge is to
create a strategy that fits your goal and personal nature. Trying to negotiate with your personal traits
is a lost game. If you hate all and anything that has to do with cannabis, how will you be able to do
good trades in the many popular cannabis stocks?
It is obvious that in bull markets (rising markets) you can allow yourself higher risks, while you must
limit your risk in bear markets. But if you don’t know the state of the market, how can you set your risk
level? You should always grasp the importance of knowing your starting point like it is the basis of
everything. It is not obvious that there is a different interpretation of volume in bear and bull markets.
However, it is a different interpretation, and this will be discussed, and exemplified later. The main
point is that volume is vital to determine a good entrance and exit point in stock trading. If you
understand that in a bull market liquidity is flowing into the markets, the opposite is happening in bear
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markets as people would seek other and
safer investments or simply put their
money in the bank. This understanding
makes sense to why in a bear market less
volume can affect the stock price even
more. If you ever sold anything you would
have noticed that selling your skies in
winter is far easier than in summer,
especially when it comes to price.
Which stock to pick?
You don’t, you let the stock be picked for you.
If you’re a good trader you have good strategies, and these strategies pick the stock(s) for you. By
following a strategy, you will also be able to identify mistakes and learn from them (nature).
Creating a strategy is a lot easier than you think, but it takes time to create a good one. A good strategy
is shaped around your personality and trading capital. If the strategy is not aligned with your
personality it will be extremely hard to follow it. If your God is Elon Musk, and Tesla is your dream car,
you will never be able to sell or buy Tesla (TSLA) when you should. If you are not patient, you should
never get involved in illiquid stocks as you can be stuck for months waiting for the slightest move. If
you have limited capital, you should avoid CFDs as nobody can predict the market accurately and
margin trading is the way to lose your money unless you can buffer the unexpected events that will
happen. Remember, it only takes Kim Jong-Un 1 minute to crash all markets in the world or Elon Musk
one evening with cannabis to send the Tesla stock on a wild ride.
Defining a strategy - the start
Defining and making a strategy is not something to be learned in 5 minutes, so I will do my best to
keep it simple. The first question you should ask yourself is: “What is my trading capital?” and the
second questions should be: “how much of my trading capital can I lose?”
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What is my trading capital?
Earlier I told you there are 2.800 stocks at New York Stock Exchange (NYSE). If the answer to question
1 is that you have USD 1.000 to trade, you should only trade 1 stock at a time. This is simply because
there is a fee involved when trading and this can typically be in the range of USD 5-20 per transaction.
If the stock you buy costs USD 100 per stock you will get 10 stocks and with a transaction fee of USD
10 per trade, it will need to move up to USD 101 just to cover the fees. In addition, there is a sell fee,
so the stock must pass USD 102 before you can even talk about getting profit. In the world of trading,
a 2% gain (USD 100-> USD 102) is a good gain. If you have USD 10.000 the answer is different as you
now will need to pass USD 100.20 to start gaining if the trading fee is the same USD 10 per trade.
Usually, the broker has different fee levels depending on the size of the trade, but for online trading,
the standard is moving towards a flat rate not dependable on transaction size.
You should never put yourself in a situation where you need to free up liquidity from your trading
capital to pay for other goods or services because in most cases you will be forced to sell at the wrong
time. Your trading capital should never be a part of your daily household. It should be considered as
long-term saving. As a trader there will be situations where the markets will give you a huge negative
surprise and leave you hanging with huge losses. Your portfolio may be down by 25% over night. In
these cases, the best solution may be to ride out into the storm and just sit tight. In other cases, you
should sell and take the loss straight away to prevent even bigger losses. These events may be outside
of your control, like a volcano eruption or a geopolitical event. Hence the next question would be: how
much of your trading capital can you lose?
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How much of my trading capital can I lose?
Knowing how much you can lose will help you tremendously when creating your strategies. If you
cannot lose more than 20% of your capital, there will no longer be 2.800 shares for you @ NYSE. You
will have to remove all penny stocks (stocks under a dollar) since these are too volatile and
unpredictable, and 20% change is almost a daily occurrence in these stocks. In addition, you will also
have to remove all other stocks that are considered high risk (risk can be defined by some different
parameters and we will get to it later). After these few changes there will be only 500 out 2.800 stocks
left for you and still, there is no 100% guarantee that you will not lose 20%, but you have reduced the
risk according to your strategy.
If it is a bull market, most of the stocks can be a good pick, but if it is a bear market - as few as 2 out of
the 500 will be a good pick. So simply by answering 2 questions you already minimized the amount of
stocks to pick from tremendously. Now the logic behind the answer: “you let the stock be picked for
you” to the initial question: “which stock to pick?” starts to make sense. The two initial questions make
your base. The 3’rd question should be: “What risk do I want?”.
What risk do I want?
If your answer is high risk, there will only be a few of the 500 stocks from the first selection that fit
your criteria. There are no penny stocks left or other highly volatile stocks, but there is a major
difference between buying stocks from solid companies like Boeing (BA) and Walt Disney Company
(DIS) from both technical analysis and fundamental point of view. One can be considered to have more
risk than the other. You can have a guess which one. Later we will get to which parts define the risk
and how this can be seen in the chart.
So far, we have defined 3 points forming your strategy and looked at how this has reduced the
number of stocks to pick on NYSE from 2.800 stocks to less than 500. Now a strategy can be
vocalized:
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Just formulate your strategy:
“I will invest USD 1.000 for trading at NYSE. I will cut my losses @ USD 800 and not invest into
penny stocks or stocks with extreme volatility. Any stock should have the minimum. I will invest
in 1 stock at the time and for all stocks passing my first criteria I will select stocks with a higher
risk”.
We can table it to make it easier to read:
My strategy
Investment capital
# Stocks
Exit level (stop-loss)
USD 1.000
1 (only 1 stock in portfolio at the time)
USD 800
Criteria 1
Trading price > USD 10 (remove penny stocks)
Criteria 2
Medium risk level
Sort by
High->low risk (what is left to choose from)
This is not a very well-defined strategy, but it is far better than random stock picking. It will also make
many decisions for you. If you lose 20% of your capital, you are out. You will not attempt to re-gain by
investing more or with higher risk. You will neither sit in 3 stocks paying, for example, USD 15 in fees,
but instead in one stock paying USD 5.
If you got USD 10.000 the situation is a bit different. The amount of cash will allow you to work your
risk differently. While being in only 1 stock at the time everything falls and rises within this 1 stock,
but if you have 3 stocks it is different. In the case of 3 stocks, it is enough that 1 gets strong gains and
the others don’t collapse. It is simply a different ball game.
Since strategy reduces the number of stocks you can select from, it will also be easier to pinpoint what
went wrong if your trading does not yield. When you have been trading for some time you will realize
that not only stocks but also whole sectors move differently. One sector may, for instance, go down or
underperform in a strong bull market. This may usually relate to fundamental news like falling oil prices
or some regulations. If you work by your strategy but keep picking stocks from the underperforming
sector, you may end up losing money. Your first idea will then be that trading by strategy is just bullshit.
But what your strategy needs is to be tuned. If you have some cash, you can easily avoid this trap by
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having a rule that you will never have for instance 2 stocks in the same sector. Personally, I like to add
one of the most important factors in stock trading;
- Know your fundamentals.
Define your strategy - Knowing your fundamentals, part I.
Over the years I have both heard and lived by many different trading rules. The very first mistake I
made was falling for this “rule”: “A chartist (short for the person using technical analysis when
trading) does not care about fundamentals…”
Not knowing fundamentals is one very certain way to lose money. If you as short-term trader don’t
know that your company will release “earnings report”, you will be in for a big surprise. You may end
the trading day with a super profit to see it be blown away on opening the next day as earnings have
been released after trading hours. If you for some reason are using leverage (only covering e.g 10% of
the buy cost) you can be forced to close your position losing absolutely everything. Knowing
fundamentals and understanding how things affect each other will allow better trades. Let me give
you an example:
Not too long ago (2013-2016) the Ebola virus spread killing thousands of people in Africa and several
cases were reported in Europe
as well. A hunt for a cure was
initiated and billions flowed
into the biotech markets. I put
my bet on a few companies
and got very lucky on Arbutus
BioPharma (ABUS) formerly
known
as
Tekmira
Pharmaceuticals Corporation
(TKM) doing a 3X in just a few
months. After some research, I knew Tekmira was one potential company to release some “breaking
news” and so they did.
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As the Ebola threat increased, the disaster was all over the news. In one live broadcast, I saw people
being interviewed in Hazmat suits (full protection suits). I then instantly started to look for
manufacturers as I knew there probably would be higher demand than supply pushing prices up (and
thereby stock prices). My second bet was on the US company Lakeland - yielding yet another great
profit. In both cases, I knew that the fundamental news would likely
push the stocks.
It is perhaps a grotesque and inhumane example praying on others misery. But it is a perfect example
of why fundamentals matter. As money flows into the biotech sector, it left other sectors causing
otherwise good stocks to fall. The concept of “fixed” liquidity is perhaps the most single important
knowledge I can teach you. Like every concept, it has modifications and exceptions, but the general
usage is very simple. And the easiest way to explain the concept is to imagine a bucket of money. From
this bucket, all economic activities share the money. If some activity uses more money, it will be less
for other activities. If interest rates are low, more money flows from banking and into the stock market.
The flow of new capital is the only way to sustain growth and at some
point, you reach a level where there simply is no more money. If the
growth stops or even declines, money will flow to more lucrative
sources. We can use the same concept for single stock and
understand that at some point there will simply be a lack of more
investors to push the stock further up. There are several indicators
to measure these relationships like RSI, volume, hausse etc. We will
get to them all.
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This far we established the need for a strategy and the need to know your fundamentals. You should
at any time be able to answer; Where is the market right now and what company have, I invested in?
This knowledge will help you to understand and interpret your results. Knowing what reasons were
behind each buy and sell will enable you to refine and work your strategy better. Let us say you invest
into the chip maker AMD that recently (January 31st, 2018) posted record results for Q4 (fourth
quarter). If you read their comments and the results you would see that some of the results are due to
the huge demand for graphic cards for cryptocurrency mining. What happens if crypto prices collapse?
China already banned all crypto and Russia is considering the same…. Or let us take another example.
You invested into SnapChat (SNAP) at USD 26.50 and currently your stocks are traded at USD 13.50.
Bad luck? Or is the fact that SNAP had an insane valuation on their IPO (initial public offering - when
they got listed on Nasdaq) compared to most other companies? If you look at Facebook (FB) and
SnapChat (SNAP) you can easily understand why FB is far easier to capitalize. If you look behind the
numbers you will also see that FB keeps growing user base, while SNAP struggles.
Adding more elements to your strategy
With a minimum of fundamental knowledge, you can add elements to strengthen your strategy. These
can be:
I will not sit in stocks that are about to publish economic reports (Q’s).
if your more advanced you can:
I will put automatic stop loss 1.5% under current price (stock will be sold automatically if
price hit falls 1.5%l) on the day results are published.
My strategy
Investment capital
# Stocks
Exit level (stop-loss)
USD 1.000
1 (only 1 stock in the portfolio at the time)
USD 800
Criteria 1
Trading price > USD 10 (remove penny stocks)
Criteria 2
Medium risk level
Criteria 3
No stocks held by the time of quarterly reports
Sort by
High->low risk (what is left to choose from)
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By doing this you reduce your risk substantially. Furthermore, it forces you to pay more attention to
the stock(s) in your portfolio. Like cash is king. Knowledge is too.
Define your strategy - Knowing your fundamentals, part II
So far, I have tried to make you understand that you need to know some minimum fundamentals like,
in what part of the cycle is the market (are you investing in a bear or bull market)? What is the core
business of my stock (know your stock)? I have mentioned that there is a level of liquidity in the market
and that if it flows into one sector another may lose. In this decade my two favorite sectors have been
technology and biotechnology. I have also followed raw materials as the ever-growing human
population and an increase in living standard is putting its toll on resources. For instance, have the
salmon farming company Marine Harvest (MHG.OL) gone from NOK 10 to NOK 163 in just 9 years.
After some correction, I am very sure that fish production will continue to be a good investment for
the next few decades.
As a trader, opposite to a long-term investor, you jump in and out of stocks. You seek short term profit
and that means increased risks. You will have to pick stocks with high volatility. However, staying in
trending sectors and industries will save you a lot of risks. There is a lot of investors that lost money
on old video store chains, and many that made a fortune on Netflix. Being a big brand is no guarantee
of success. Large corporations are in need of big cash flow and if this dries up they are in a huge
problem. A good business may overnight become a nightmare. The last proof of this is the oil industry
which took a hard hit when oil plunge from USD 100 (Brent crude) in the summer of 2014 to USD 35 in
the winter of 2016. Why would you try to fight a falling oil price investing in oil shares? The answer to
this is usually lack of knowledge and the fact that hope is stronger than common sense. To buy shares
is easy, selling is hard.
Earlier I pointed out that the liquidity is just shifting from one thing to another. When banks lower their
interest rates making saving in banks less attractive, money goes into the stock market and vice versa.
If the money goes out from one sector in the stock market it usually flows into another sector. The
huge fall in prices of oil took its toll on oil shares, but at the same time, it was a boost for the airline
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companies that now could lower their running costs. While oil prices were plunging from summer of
2014 till the beginning of 2016, the Norwegian Air Shuttle company (NAS.OL) went from NOK 180 to
NOK 380. As a trader, you need to utilize these fundamental movements. Trading oil-related stocks
(except shorting) when oil prices fall would require extreme precision and picking, while you could pick
almost any airliner and do very good in the same period.
Depending on the amount of capital you are trading with you should define your main sectors. Good
advice is to make a table and just write scores for each sector as you see it. You can use news sources,
your gut feeling or technical tools like Hausse indexes that are found at StockInvest.us. Hausse indexes
are one of my personal favorites and in short term, it simply measures the relationship between buy
and sell signals. Too many buy signals and the risk increase heavily, while the opposite happens if there
are too many sell signals. Hausse indexes can be made from a long range of both fundamental and
technical signals. The table below is from StockInvest.us and was copied the day before -3% fall in the
US markets.
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As a trader, you can utilize this information in the way you play your risk. There is no contradiction in
having a financial sector as the main area of investing in your strategy and reducing your exposure
when Hausse indexes are high for this sector. I will get into more details about working with risk in
later chapters. I also need to mention that there are Hausse indexes for all time periods - even including
intraday.
Bit by bit I hope you are now able to see how your strategy is picking the stocks for you by the method
of elimination, and keep in mind that if you follow a strategy the results derive from the strategy. A
wise man once said: How can I change something if I have no clue what I am doing wrong?
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Define your strategy - Knowing your fundamentals, part III
By now we understand that liquidity flows and a small, but very good proverb comes to mind: “Follow
the money”. It is one of the oldest and most basic principles; the path of less resistance. It is widely
used in marketing and referred to in the bible as greed. If it is easier and safer to make money by
placing them in the bank (high-interest rates), money will flow out of stock markets into the saving
accounts. If it is easier to make money on technology sector than industry sector, the money will flow
from industry to the technology sector, and for stocks to rise they will need a constant supply of new
cash.
A contradiction is that stocks with no seemingly fundamental reason, like big earnings or agreements,
do huge gains in short periods. Example of this is stocks like Tesla [TSLA] and Snapchat [SNAP] which
both operate in deep red, burning investor's money like crazy.
No matter how insane this is, there is no point to argue that there is far less resistance in beliefs than
cold hard facts. If enough people believe that a stock is a good buy it will go up no matter how bad the
fundamentals are. Very often there is a huge and professional marketing apparatus pushing news after
news to shape the investors’ mind. There is no point in fighting such stocks with short selling. Until the
day they find their tipping point, you should stick to simple but powerful proverbs like “follow the flow”
or “let the trend be your friend”. The tipping point for stocks like this, where they go from gainers to
losers, can often be seen in the content of the news. In the end, they will be more and more desperate
and often not even related to the business itself. This will often be backed up by the major players who
will do the famous pump and dump. In pump and dump, brokers start heavily recommending the
stocks, boosting them while the major players sell their stocks.
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In other cases, brokers fire up the stock doing some larger purchases (often when liquidity is lower
than usual) and then off-load all stocks while you think the stock is on the roll. You should, therefore,
keep an eye on the news, insider information and shareholder structure. The market is two-faced and
the same is with the owners. They often say one thing while doing the totally opposite. Since the
beginning of 2018, Snapchat [SNAP] has been rolling out their new changes to their application. These
changes have (as of Feb 15th, 2018) gathered more than 1 million signatures from users who wanted
to revert it back to the old design. However, CEO Evan Spiegel claimed the design is there to stay and
that it will benefit both users and the company (income). Nevertheless, new records show that on the
14th of February 2018 the same Evan Spiegel sold more than 2.65 million of his own shares for a value
of more than USD 50.1 million. Other insiders, like Director Mitchell Lasky have been selling 25.000
stocks every single week since November 2017. Why?
* Source: https://www.gurufocus.com/InsiderBuy.php?insider=Spiegel+Evan
In stock trading, it is very much about the future. When you're buying or selling stocks you're doing a
prediction. You either predict it will go up or that it will go down and place your bet. Companies that
got high valuation are either making good yearly profits or there is a belief that it will do very good
yearly profits (predicted). The valuation is often measured by price-to-earnings [P/E], price-to-earnings
growth [PEG] or price-to-book [P/B] which in short term look at the value of all the company's assets.
I would not claim it as a necessity to know these definitions unless you're doing a value trading. There
is simply too many variables included, like the type of industry, the maturity of the business etc.
Neither does the stock market pay daily attention to it, but sooner or later it will have an effect. No
company can run endlessly in the red. There is only a limited amount of capital and investor trust.
Some of the worst news that can hit you if you're not prepared: when a company is issuing new stocks,
this can take 5-20% of your profit or increase your loss in minutes. It is very seldom that companies
can get more money without offering some sort of rebate. I may be very wrong, but I believe Tesla will
be such company, asking the investors for more and more money to support the dreams and visions
of Elon Musk. It may work very well, even be smart, in bullish markets, but can be totally devastating
if the bear is roaring.
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Include fundamentals in your strategy
In your strategy, you should account for the fundamentals. If your focus is the financial situation of the
company, you will use the methods mentioned above. You can, for instance, have in your strategy that
you will not invest in companies that have P/E higher than X. Again, you will see that the number of
stocks to select from will be reduced, and hence your strategy will pick the stocks for you. If everything
gets very confusing and you just like to follow the market you can use the Beta coefficient. Beta is a
measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the
market. You may find this strategy boring in your pursuit for quick wealth, but remember the phrase
“easy come, easy go”. Even following a Beta-strategy will not make you safe. Let me show you a recent
example:
If you invested in the company Apricus
Biosciences Inc. [APRI], that has a Beta of only
0.26 (low risk), you would have seen a 67.40% loss on Friday, Feb 16th. 2018. The
huge loss came after the company got a
rejection to start marketing its topical erectile
dysfunction (ED) drug Vitaros from the Food
and Drug Administration (FDA). In this case,
APRI closed @ USD 3.12 on Thursday and
opened @ USD 1.07 on Friday. No stop-loss in
the world would have helped you.
It is important to understand that this is an exception and a special case. If you follow a Beta strategy
you will be more right than wrong if the market is in an upward trend. The only way to reduce all risk
is simply by not investing in stocks at all. It is also worth mentioning that APRI is a high-risk stock both
fundamentally and technically (based on daily trading volume) and with defined risk level in your
strategy you would have never bought APRI in the first place.
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Define your strategy - Before we move on
As earlier established, you should base your trading on a strategy that considers your financial strength
(size of portfolio), your desired level of risk, the segments/sectors you like to trade and so on and so
forth. With a good and well-defined strategy, you will not have to “find” stocks, they will be found for
you. The 2.800 stocks at NYSE will be reduced to maybe as little as 10 stocks fitting your criteria. To
find the one stock to buy we will use my favorite tool - technical analysis. But before going there - some
last thoughts about fundamentals and strategy.
Learn to evaluate your actions
It is easier to become a good trader if you understand that you will do bad decisions. In fact, you will
most likely to lose money before you make some. The main point is that you must learn from it. Buying
is easy but selling is hard. No matter what you think, emotions will come to play. Greed and fear are
written in stone. If your picks are done by a defined strategy, at least you will know what you must
change. Changing yourself as a person is close to impossible. Why would you select high-risk stocks if
you're an impulsive person? Playing high-risk stocks requires true dedication and emotionless decision
making. Even after 20 years of playing the stock market I still have not managed to transform my
personality enough to play the “high ball”. My most common mistakes are entering too late and exiting
too early in runners and selling too late in stocks that do not perform or drop. Knowing this, I decided
that I would never play more than 1 high-risk stock at the time, and it should always be less than 20%
of my total portfolio.
Information will try to fool you
Information is found at many sources, but always ask yourself who can benefit from the
information/news. An article written by Forbes is no guarantee against false or misleading information.
They will write and publish anything that sells. Often news companies are fed with information that
has a very specific intention. In politics there are dirt packs and the exact same applies to the stock
market. Reports are “bought” from scientists and published. Lobbyism activities in politics are just the
same as in the world of business. Why would Elon Musk and SpaceX wait with launching the heavy
lifter with a Tesla onboard just before Tesla released the worst quarter (Q4) numbers in the company's
history? Coincidence or a brilliant move by Mr. Musk? By continuously pushing all kinds of news Tesla
avoids the main question like what to do when they run out of cash? According to all logic and number
crunching it is not a question if, but when. As an investor and a trader, you should ask yourself if you
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should go all in or portion your risk. The upside in Tesla is huge, but there is no free lunch. Tesla is also
one of the most shorted companies in the world when this is written.
Pump & Dump
I have mentioned “pump & dump” a few times so far in the text. “Pump and dump” come in many
shapes and colors, but the intent remains the same. Pump up the stock, then dump it. If a stock
suddenly starts to get a lot of recommendations without any big fundamental changes ongoing - a bell
should start ringing. Some famous broker sees a “possible” potential. Vague articles with a lot of
scenarios that give huge profits get published. Figures are just great. Suddenly the volume starts to
move, somebody is buying large quantities. Brokers issue an alert to their smaller clients. XXX is moving
and the potential is very good. The stock starts firing up, - 5%, 10%, 50%. The smaller day traders jump
in believing this is the next big thing, but the air goes out of the balloon and the stock falls back to the
initial price or even goes red. During the 3 trading days from March 6th to March 8th Diffusion
Pharmaceuticals Inc (DFFN) went from USD 3.80 all the way to USD 11.00 just to end trading on the
8th @ USD 5. There is no great logic behind the movements. The up and down cannot be argued by
fundamental changes within the company or the market it operates in. Price is decided by the
investors. Money talks. As the proverb says: “If something sounds too good to be true, it usually is.”
I often see attempts of stock pumping in stock-related forums. Users saying that “news” will soon
come, or rumors on a potential deal. Since large companies often require large volumes to be moved,
these attempts are often towards minor companies with low daily trading activity. For many years
biotech stocks have had hot
“pump” cases amongst day
traders and smaller players. A
very typical pattern for such
stocks is a long period with very
little trading - then huge price
spikes, where stock afterward
goes back to a vegetative state
like in the chart below. In most
cases, these types of stocks are
“penny stocks”.
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If you are aware of this type of behavior you can do a lot of good trades. I often post possible runners
on our twitter account https://twitter.com/StockInvestUS asking the followers to keep an eye on the
volume. The main rule is that volume should
follow price. If this is the general pattern for the
stock, there is a high probability the price will
increase next time volume starts moving. In
these cases, volume is the signal verifier. Cases
with high price changes without volume are
often false and can in worst case lock you in a bad
position. You get in @ e.g USD .90 and stock
instantly drops to .75. Low volume gives huge
price gaps and stop-loss is not being triggered. If
people get a sudden loss of 15-20% most decide
to stay in the stock hoping for a better exit. With
stock going all dead again you get locked in the
stock
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