What to Do with Price Spikes and Price Dips in Penny Stocks - dummies

What to Do with Price Spikes and Price Dips in Penny Stocks

By Peter Leeds

To be successful in penny stocks, the ultimate question is when to sell. Investors often take price spikes and price dips as an indication that they should make a move. Fluctuation is normal, so when should you sell?

Price spikes in penny stocks

Penny stocks are prone to spikes in price, which can sometimes be a sign of even higher prices to come but is most often a profit-taking opportunity. Sudden and dramatic leaps in the price of shares often come back down just as suddenly and dramatically.

As penny stocks have fewer buyers and sellers, the likelihood of a price spike is higher than with most other forms of investment. When several investors buy at the same time, whether it’s based on coincidence or Internet hype or otherwise, they may outnumber the sellers, resulting in the shares suddenly being much more expensive.

As these price spikes are most often based on the technicalities of trading rather than on any underlying materially beneficial events, you should consider them artificial and temporary. As such, they’re very often profit-taking opportunities for alert shareholders.

You should assess any price spike based on the following criteria:

  • Trading volume is below average. If the upward move was on lower than average trading volume, it is likely to reverse.

  • The upward price move is significant. A true spike will see gains of at least 20 percent above the pre-spike prices and perhaps as much as 100 percent or more.

  • The spike was not based on any news or event. When the shares trade higher without any tangible reason, you can expect that they are likely to come back down to former levels.

  • Shares immediately begin to reverse. A true price spike won’t last long. Sometimes the shares fall back from the higher levels within minutes and hours — and certainly within a day or two.

When shares leap to much higher levels on low trading volume, and you find no news to justify the price increase, you’re dealing with a temporary price spike. When the shares immediately begin to reverse and trade lower, you can be even more certain — especially if you’ve taken your profits already!

Price dips in penny stock

Much like price spikes, penny stocks are subject to a similar effect to the downside, called a price dip. When the buildup of sellers overpowers the number of investors looking to buy, the shares of the underlying penny stock can sometimes drop significantly.

Investors who understand that the price dip is a temporary event will be able to buy shares at discounted prices and will benefit as the shares snap back to realistic valuations.

A price dip can be identified as follows:

  • Trading volume is lower than average. Unless shares are falling on average or greater than average trading volume, the move is likely to reverse.

  • Downward price move is significant. In terms of percentage, the drop-off greatly outweighs the average change in share price. For example, a 10 percent drop when the average price change from day to day is closer to 2 percent is a significant downward price movement.

  • No news or events created the drop. When shares fall but no news or material events are pushing the stock lower, you may be seeing a temporary technical dip and potential buying opportunity. Just make sure that you’re not missing any publicly available event that could have significantly negative impact.

  • Shares begin snapping back higher. A price dip is temporary, and the stock will snap back to realistic valuations rather quickly, often within a matter of hours. The investors who profit from price dips are often the ones who were already watching the shares and were ready to take advantage of just such an opportunity.

When shares drop significantly (in terms of percentage), on low trading volume (in terms of daily averages), with no detrimental news to be found, you can expect the shares to snap back to higher prices. In fact, investors who accumulated the penny stock at these new and temporary lower prices should do very well with their investment.