What to Do with Bottomed Out Patterns in Penny Stocks - dummies

What to Do with Bottomed Out Patterns in Penny Stocks

By Peter Leeds

A bottoming out pattern illustrates when penny stock shares are about to trend higher. Bottoming out is about spotting those shares that have been sliding lower for a long time, only recently have flattened out and stopped falling, and may be setting up for a long and sustained uptrend.

When a penny stock company has fallen out of favor with investors, or the company’s operational results have been looking weak or experiencing other detrimental issues, the stock may begin a downward slide. Not until the company corrects these issues will it be back on the right track, and that won’t be until it reports its financial results two months after the end of its next three-month quarterly reporting period.

It takes a long time for shares to change their trend from downward to sideways, and then from sideways to upward, after events entice investors come back to the shares. You have plenty of time. Until the bottoming out pattern shows itself and shares begin to reverse to higher levels, there may be any number of investors getting in too early and taking losses by trying to pick a bottom.

Bottoming out patterns are great when you want to get involved very early in a brand-new uptrend with a long way yet to run. You can spot a bottoming pattern only when all the following criteria are met:

  • Predicated by a long decline. A bottoming out pattern can only exist after a long, sustained, and significant decline. Just make sure that the decrease in share price isn’t related to a detrimental material event that isn’t being resolved. If a massive competitor is putting the future of a penny stock in doubt, rather than establishing a bottoming out pattern, this could be shares on their way to zero.

  • Set up by a sideways trend. Shares rarely go from sliding straight down over time to turning straight up. Expect a long a transition period, in which some shareholders are still selling when others start to buy at these lower levels. This will result in a sideways trend, where shares are neither heading higher nor lower.

  • Frequency of up days improves. As you transition from downtrend to sideways trend, you may see an increase in the number of days that the shares trade higher. A ratio of one up day for every two down days may become one-for-one. An average ratio of two higher closes for each down day indicates that the bottoming out pattern has formed and will send shares higher.

  • Trading volume increases. Trading volume needs to rise, putting it at least 50 percent above the daily average during the sideways trend. Keep in mind that these new lower prices should see higher trading volumes, because it takes less money to buy more shares. For this reason, the higher the trading volume increases, the greater the likelihood that the bottoming out pattern is about to turn into an uptrend.

The most important aspect of any TA pattern is timing. With bottoming out patterns, don’t act until the shares are well into their sideways trend, the ratio of up-to-down days turns in a positive direction, and the trading volume swells.

When all the criteria mentioned above occur, you’re very likely to be witnessing a bottoming out pattern. When shares bottom, they eventually enter an uptrend, and take astute investors along for the profitable ride.

You may have heard the popular stock market term, “Don’t try to catch a falling knife.” This refers to trying to pick the bottom price on shares as they have been falling. Many investors think that “now” is finally the lowest the stock may drop, and they get burned more often than not.

If shares are falling, let them finish their price slide and level out before you get involved. Remember, even shares that have already fallen 80 percent still could go lower. Just ask the investor who bought after they had fallen 65 percent!