In the financial market, timing a stock well could significantly reduce the risk of loss.
Entering a stock near a support level of on a breakout could potentially improve the odds of a winning trade.
A major fundamental shift in the company could also be an ideal time to buy penny stocks.
Penny stocks are often tagged as a high-risk investment. However, Warren Buffet rightly said, “risk comes with not knowing you are doing”. One of the major reason why penny stocks are difficult to trade is their unexpected moves due to a relatively higher level of volatility.
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In the financial market, timing a stock well could significantly reduce the risk of loss. Timing here means buying around a price level which might give you a very good risk-to-reward ratio, hence a few big profitable trades could outpace a few small losses. Keeping in mind the significance of timing the penny stocks, here are three important set-ups where it could be an ideal time to buy penny stocks.
Read more: Five ASX penny stocks for dividend fans
Look for support zones
A support zone is an area on the chart, from where a stock is expected to halt its down move. This area is identified by looking at the price chart and spotting previous major troughs (from where the stock reversed).
The underlying premise being, if a majority of people have bought the stock earlier (leading it to surge in price) then they might again buy around the same levels in the future. Hence if the stock hits the same support zone again, it is expected to bounce back, and it could possibly be a good time to buy.
Enter on breakouts
Opposite to buying near the support level, entering a stock which is staging a successful breakout, means buying above the resistance level. A breakout means, a stock is trying to break above a major resistance level.
A breakout is an ideal set-up to buy a stock as it generally leads to the beginning of a new trend, or continues an existing one with new force. A high level of volume is needed for the stock to surpass its resistance level, which indicates an increased interest in buying that stock among market participants.
A turnaround in the company
The above two methods were based on technical analysis. However, if there has been a major fundamental shift in the company, which could potentially turn around its business, then also one can look to lap up the stock.
This major shift could be – a drastic change in the management, a new acquisition, entrance into a new market or the launch of a new business vertical. Penny stocks with a change in the underlying fundamentals are a good candidate for potential multi-baggers.
Related article: Five things to keep in mind while trading penny stocks
Although penny stocks might pose a higher risk, but much of the risk can be managed efficiently by timing the stock well. While there are some ideal set-ups like buying near the support zone or entering a fresh breakout, there are many other strategies to time a stock well.
A trader/investor must do his own due diligence to identify these ideal set-ups and can take the help of his financial advisor before making an investment.