Professional Documents
Culture Documents
Penny Stock e Book
Penny Stock e Book
For example, 12,343,000 shares of ABC at $0.29 each gives ABC Corp. a market cap of $3,579,470
(12,343,000 shares times $0.29 per share = $3,579,470). That is kind of like saying that the company's total
value is 3.5 million dollars. In some cases, organizations or individuals will treat any company beneath a certain
market cap (for example, less than $10 million) as a penny stock.
Interestingly, using option 1 or 3, a company can have its shares change in price moment by moment, and may
drop in or out of the definition of 'penny stock' over time. What may be a "penny stock" when the market open in
the morning, may not be a penny stock by noon.
In some cases the definition of penny stock is generated by a combination of the above criteria. For example,
any stock trading on the OTC-BB with a market cap of less than $20 million is considered a penny stock.
I treat any share that trades under $2.00 as a penny stock. The Securities
and Exchange Commission (SEC) considers any stock below $5.00 per
share to be a penny stock.
Defined by Market
Capitalization
Stocks with less than $50 million in total capitalization can be considered
penny stocks, but this market cap cut-off varies greatly from one
organization's definition to the next.
It is worth repeating: I treat any share that trades under $2.00 as a penny stock.
I have specifically developed my techniques and trading methods to apply to shares less than $2.00 in price.
However, keep the other definitions in mind because what is and is not a 'penny stock' will depend on who you
ask. The only common characteristic that we feel holds true from one definition to the next, is that penny stocks
are high risk, high reward investments.
Penny stocks are high risk, high reward investments. It is easy to lose money on a penny stock investment.
However, if your shares do begin to move, they can produce hundreds of percentage points of gains, and they
often do this in only a short time frame.
Penny stocks are often very volatile, and just as often unpredictable.
In most cases, penny stocks are considered to have higher risk and higher potential rewards than most other
'more conventional' investments. Their speculative value can be extreme, and their visibility of information and /
or accessibility of operational results is usually very poor.
Few financial professionals venture into the field of penny stocks because they are either unwilling or unable to
do the work required to accurately predict what these highly explosive shares may do.
Or perhaps some big-wig investment types feel that low-priced shares are 'beneath' them. Hmmm. I could have
retired when I was 26. Is that beneath them?
Speculation
Speculation is based on penny stock companies having lower available information about their operations,
minimal revenues, unproven management, and often an unproven product or industry.
A big-name company like General Electric or Ford Motors will have very little speculative value. In other words,
you will probably not make hundreds of percentage points on your shares, but instead would be happy with
returns of 10% to 20% per year.
In some cases, traders even use large-cap stocks to hedge or protect their portfolios, out-perform the market,
preserve their capital, or diversify their exposure.
On the other hand, trading penny stocks with hopes of selling when you have realized a 20% gain might be
folly. Penny stocks make their gains by the hundreds of percentages, and thousands, not by the tens.
There are many bad investments in the penny stock field, so the best way to succeed is by isolating those with
superior speculative value. The chance of buying into shares of the company that could multiply 10 or 20 or 50
times in price is the whole idea of speculation.
In contrast, it is not possible to calculate the actual worth of most penny stocks. Some do not have inventories,
a revenue stream, or even a proven product. The shares rise and fall based on buying and selling demand, and
that demand is driven mainly by waves of speculation.
By their nature, it is nearly impossible to know what price a penny stock share should be trading at, and
conventional financial ratios and industry comparisons are rarely effective measures for realizing a penny
stock's tangible value.
Value and
Predictability
Fundamental Analysis
and Information
Availability
Technical Analysis
Volatility
Spread
Revenues and
Company Life-Cycle
PENNY STOCKS
Highly speculative. For some penny stocks,
speculation is all they have going.!!The better
penny stock companies often see their shares
soar on speculative buying.
Less actual value, greater perceived potential.
Penny stocks are also very unpredictable.
Poor visibility levels, lower reporting
responsibility.!!Can be researched properly if
the Leeds Analysis method I describe in
Chapter Three is applied.
TA methods cannot be applied to penny
stocks, except for the proprietary techniques
and indicators I describe in the second half of
Leeds Analysis later in this book.
Highly volatile, with more frequent profit-taking
opportunities, and greater price swings.
Sometimes there is a gap between prices of
buyers and sellers.
BLUE CHIPS
Little or no speculative value.
Dividends
Takeover or
Acquisition Targets
PENNY STOCKS
Very rarely pay or are in the position to pay
dividends.
More likely to be taken over by another
company, which is usually very beneficial to
the price of the shares.
Investment Horizon
BLUE CHIPS
Many blue-chip stocks pay
dividends.
More likely to be the company
purchasing or taking over the
smaller player, which is usually
detrimental to the price of shares.
Insulated to the impacts of the
sector and industry.
Benefit from economies of scale,
but can not respond, react, or adapt
to the smaller companies quickly
enough. Often leave niches
exposed for penny stock companies
to capitalize.
Fundamental results and the
balance sheet are the most
important factor to the share price.
More stable, less volatile.
Brokers will not be problematic for
trades in blue chip stocks.
It often takes larger, slow-moving
companies years for their share
prices to advance meaningfully.
Volatility
Penny stocks can often undergo dramatic price swings, and often these moves can be on nothing more than a
large buy or sell order. It is not unusual to see your shares drop or spike 20% or 50% or more during a trading
day, and even return to their original starting point by the end of that same day.
When a company does come out with a significant press release, for example a biotech gaining FDA approval
for its latest drug, expect the shares to make a big move, and even potentially build upon that advance the
following few trading days. Price explosions of several hundred percent in a matter of hours or minutes are not
uncommon.
Spread
Stock markets try to match up the highest bid price (to buy shares) and the lowest asking price (to sell shares).
When these numbers match a trade takes place. For example, when you see a price quoted as $0.25, you
know that the last trade was when a buyer and a seller both agreed upon $0.25 for their transaction.
At all times when the bid and ask are not matching, there is a spread. For example, if the highest bid is $0.80
and the lowest ask is $1.00, the spread between the two will be 20 cents.
You will quickly find that penny stocks are subject to much larger spreads (on a percentage basis) than more
heavily traded stocks. It is common to see penny stocks with spreads of 15% to 30% when the buyers and
sellers are not agreeing upon a price.
The growth phase, when companies become discovered by the public and the financial industry, is when they
usually enjoy the greatest share price movement.
As a company matures, they begin looking for additional complementary products and services to sell. They get
their fiscal situation in order, turning those revenues into earnings, and may even pay dividends.
This process from new company to mature corporation takes years. Microsoft was once a two-man operation,
and they had an office sign that was scribbled on a piece of cardboard. They enjoyed an explosive and
arguably the most dramatic growth phase in the history of the stock market, and now have hit maturity. They do
not expect to keep advancing at their explosive rate, and are looking for alliances and ways to consolidate their
industry position.
It is important to know that the majority of penny stocks are in the pre-revenue or very early growth stages.
Many do not have revenues, and just as many have yet to prove that their concept or operational strategy has
any merit.
Many penny stocks in this infancy stage are 'story stocks,' meaning that they have investor interest because of
their potential. They have a great sounding 'story' or idea (for example, a new technology or drug that could
revolutionize an industry), but have yet to prove it, or to show that they have a method to capture market share
or educate society about their concept.
Dividends
Some larger companies, or those with higher cash flow, pay a portion of their cash to shareholders. Penny
stocks, being cash-strapped and in their growth phase by their very nature as described above in 'the company
life cycle,' generally do not.
However, it has happened from time to time. I once bought shares in BVR.A on the TSE (Bovar, Toronto Stock
Exchange) for $0.14 each. The company decided to unload a large cash position that it had on its books. They
paid out a one time dividend of $0.16, which by itself was higher than the original purchase price.
(Note: Part of my personal justification for purchasing BVR.A was that they had more cash on hand per share
than the current trading price). I had more money than I had originally put in just from the dividend, and I still
held the shares!
Broker Policies
Due to the lack of visibility of penny stocks, the markets they trade upon, their volatility, and their risk
factors, some brokerage houses have instituted strict policies for trading these investments.
Shares that they consider 'penny stocks,' which are usually stocks for $5.00 and under, are not option
eligible. This means that you cannot sell short, set stop loss orders, or buy on margin. For most traders
this would not be an issue anyway, because these are all more exotic trading methods, and ones that I
strongly warn against.
As well, depending on the stock exchange that the shares are listed on, you may not be able to use limit
orders to buy or sell, and will have to take the best available market price. There is much more on buying
and selling coming up later in this chapter.
Investment Horizon
Traders generally tend to hold penny stocks for shorter time frames, and attempt to get their returns from
the stock in a matter of months rather than years.
Perhaps you do not want to do any research yourself at all, but instead prefer to use a professional penny stock
picking service. This is also an excellent way to proceed, as long as you decide on a service that is reliable and
accurate.
I recommend that you do use the services of a professional penny stock analysis company, but besides
PennyStocks.com, I would not consider any of the other options out there to be 'professional.' Generally they
are individuals who have figured out how to program a web page, and their expertise does not go far beyond
that.
A Little Work
As I have mentioned, a little work can go a long way. However, most traders do not put in the required effort, or
any effort for that matter. Those of you who are willing to do the extra due diligence or analysis will benefit
greatly from what you are about to read.
Understand that 95% of penny stock companies should be considered bad or dangerous investments.
However, the proven approach outlined in the next several sections of Understanding Penny Stocks makes it
easy to tell which stocks should be ruled out.
A Long Way
As you become more experienced, you will learn that a good penny stock trader can make money on good and
bad penny stocks alike, simply by investing at the right time. Since every stock fluctuates, you shall see that
money can be made by buying even the worst companies at the right time, and money can be lost by
buying the best companies at the wrong time.
Ideally you want to accumulate the best penny stock companies at the most advantageous prices. We suggest
using fundamental analysis (detailed in an upcoming section) to discover which are the best penny stock
companies, while using technical analysis (also detailed further along in Understanding Penny Stocks) to pick
the most opportune buying prices.
Technical Analysis
This uses patterns in the trading chart to try to uncover trends, and then predict the future direction of shares. It
is also done in an attempt to uncover the best buying and selling opportunities and prices, as well as to predict
the future activity of the underlying stock.
For example, when most stocks demonstrate what TA calls a 'cup and handle' pattern, they generally spike
higher in the subsequent weeks. Thus, a cup and handle pattern may be a good buying opportunity.
What a technical analyst's desk may look like.
TA is significantly limited when applied to penny stocks, as the trading volumes and low investor interest
(compared to most stocks) negates most analysis patterns. TA works best on well-followed, heavy volume
shares like IBM or FORD.
"Conventional" TA cannot and should not be applied to penny stocks. Instead, we have developed our own TA
methodology for application specifically to penny stocks, and I detail it in upcoming sections of Understanding
Penny Stocks.
Fundamental Analysis
This approach uses the company's financial statements. It looks at the financial numbers and ratios, as well as
the corporate situation. We feel that fundamental analysis is a great starting point for screening and researching
penny stocks, and that it is an effective method of finding the best companies to invest in.
Fundamental analysis looks at things from revenues and debt, to ratios like price/earnings and debt/equity. It
then compares these with other stocks in general, and with direct competitors. Using fundamental analysis, you
will also look at such criteria as management team effectiveness, press releases, brand recognition, barriers to
entry for new competitors to the sector, among a host of other parameters.
Fundamental analysis is an excellent way to research and rank stocks. However, it becomes more difficult
when dealing with penny stocks since it is often challenging to get access to all of the required information (and
even when you do, you often need to be wary of the reliability of the facts).
Later, in the section on Information Sources, I detail how you can go about finding the information you need. In
the next section, I explain to you exactly what fundamental factors drive the share prices of penny stocks based
on our research.
Individual Concepts
The pure depth of fundamental analysis can be daunting, and as a result many trading concepts have sprung
up from FA roots to take on lives of their own.
For example, some research methods simply take one fundamental concept such as price/earnings ratio, and
use that as a way to compare investments. The companies with the lowest P/E ratios would be considered
undervalued, while the ones with the highest P/E ratios would be overvalued. (One flaw with the approach in
this example is that it assumes that all other factors are equal).
Another may look just at insider trading by itself. When insiders are buying, it must be a good time to load up on
shares, and when they are selling, they must be privy to some bad news. (Insiders are just people, though, and
often they can sell shares to raise money for their daughter's braces or a new car. Other insiders 'go down with
the ship' and never sell their shares while the company sinks. In other examples, there may not be enough clear
insider activity to reveal anything at all).
If you are sensing a trend here, it is that these 'Individual Concept' investment approaches are easily flawed.
Most are fads that may have worked on certain stocks in certain market environments, but they quickly become
exposed as ineffective once they are applied by individual investors. While traders may get lucky in some
markets, then swear by the effectiveness of the approach, all of these strategies have proven to be unreliable
from one moment to the next.
If any of these methods ever did prove effective (which they never will) it would not be long before every trader
in the world was applying them, especially due to their simplicity.
Besides, why look at only one factor of a company, when you can look at all of them? True, you may be able to
make some profits some of the time by seeing a small part of the picture, but revealing the entire picture will
help you make more money, more of the time.
Themes
You may have heard of some of them: undervalued stocks, bottom-fishing, industry leaders, rolling stocks,
momentum investing (the last of which is a spin-off from technical analysis methods). These are sometimes
effective if the market cooperates, and painful when the market misbehaves.
Sure, it is great to pick up shares in undervalued stocks when the market has bottomed out and has just begun
to rebound. But in that sort of a market, is it not also a great idea to be involved with bottom-fishing, industry
leaders, momentum investing, stocks that begin with the letter 'D', and investment horoscopes?
Look at January to March of the year 2000. The three months leading up to the bursting of the dot-com bubble,
you could not have lost money in the market if you tried! (If you did, please write to me and tell me all about it. I
would LOVE to hear how you pulled that off!)
Perhaps I am being a little harsh. Sometimes these methods listed above can help you uncover some good
shares.
Just beware of their gimmicks, and only get involved when the market is just right. As well, know that there is no
substitute to getting the entire company picture, as I detail in the next section.
The method I am about to explain to you has consistently outperformed the market.
Think of this weight loss analogy: there are a thousand different gimmick diets you could try, and although you
may see some temporary results (which do not last), they do not work. The best way to lose weight is through
changing your eating habits and lifestyle. In other words, doing the work required rather than going with a
gimmick. Similarly, the best way to make money in penny stocks is to do the work required, rather than going
with a gimmick.
I believe penny stock traders (even those that use a professional penny stock picking service) should examine
the fundamentals as described in the next section on Leeds Analysis. This will help you to discover the best
penny stock companies. Then use our specially developed technical analysis methods (also described in
Understanding Penny Stocks) to find the best buying and selling prices of those shares.
Technical Analysis
Fundamental Analysis
Comparing companies by
one factor (iePrice/Earnings Ratio).
This method is too shallow even for largecap and blue-chip stocks, and is even less
effective for penny stocks, which are a much
more complicated beast.
Short-Term Trading
Most short-term trading is driven by impatience and greed. However, the impatient and greedy investors never
develop winning short-term strategies.
If you want to trade quickly to make a quick buck, forget about it and skip on to the next section. If you want to
trade short-term because you believe that there are profitable trading theories that can be applied to stock
fluctuations, keep reading.
Subsequent Trading: You can more readily tell if a pop or dip is temporary, and perhaps a trading opportunity,
by closely watching the trading activity. For example, if a price spikes on huge volume, then you notice that the
price advance and trading volume are both significantly lower the following day, the spike may be losing steam.
If a dip is on very low volume, it usually is erased as soon as a few bargain hunters jump on the shares. If the
dip is on major volume, it may be a sign of things to come. High volume dips usually last, while low volume dips
usually do not. Thus, high volume dips are usually a warning sign, while low volume dips are often a buying
opportunity.
To benefit from the trading opportunities that pops and dips provide, you need to be able to quickly identify
them, then react just as swiftly. Take up positions in those stocks that have dipped but will recover. Sell off
shares in those stocks that have speculative price-spikes, while holding shares in companies that may be able
to sustain their gains.
I provide an examination of short-term trading strategies in this chapter, in the discussions on Volatility Play
Investing, Trading Windows, and Day Trading.
Timing
The best time to buy is right after the penny stock bounces off of the support level you delineated (which
also affirms your choice of support price).
The second best time is to buy right before the stock hits support, but is trading at only a fraction above
the support price. The problem with the latter choice is that you will be subject to those situations where
the penny stock sees the support level fail, and the price falls right through to lower levels.
The best price to acquire shares at is just above the support price. For example, if support is at $1.10,
you may want to acquire shares at $1.15 or even $1.12.
The best time to sell is just before the stock reaches the resistance level. Drops from profit takers can be
quick, so it is usually more effective to sell too early than too late.
The best price to sell is just below the resistance level. For example, a $2.00 resistance is best sold into
at $1.95. (Or even $1.85 to be safe, especially if the penny stock has a history of collapsing back to
former levels very quickly).
When investing in this fashion, make sure to factor in the fact that you will be taking more frequent commission
charges from your broker.
Also, make sure that the range of volatility is enough to support profits, because you may be buying and selling
in a tight price range of only 15% to 40%. If you are making 15% profits on a few hundred dollars, you may only
be breaking even after paying trading commissions and taking the occasional loss
Make sure that the changes in price direction and the degree of price activity are not based on fundamental
factors like news releases, changes in financial performance, or other factors mentioned in the discussion on
Fundamental Analysis detailed in Chapter Three of Understanding Penny Stocks. A company may have been a
great Volatility Play, but if it gets a huge FDA approval, the trading ranges can get thrown out the window.
Also remember that you do not necessarily have to sell all of your shares each cycle. This applies even more so
if you are not positive about the upper resistance threshold, or you are not even sure if the stock will follow your
volatility expectations. You could sell half or a portion of your position, and leave the rest to ride.
As well, you may benefit by gradually increasing the amount you invest in each cycle. If you have made some
profits and have a good feel for the stock, and the support and resistance levels have proven out near the
prices you expected, you may want to put more cash onto the table.
In any of these cases, it is best to liquidate your position as quickly as possible, trying to take only a 5% to 15%
loss. If you hold every Volatility Play that sinks past your support levels, you will eventually wind up with a
portfolio of sinking ships.
The beauty of Volatility Play investing is that you should be taking frequent profits, so the strategy allows for
some losses in the interest of the overall picture.
A Quick Secret
One of the most effective yet under-used research techniques is quite a simple one - contact the investor
relations person of the company you are interested in, and ask them some questions you have already
prepared. Let them talk and don't interrupt. Often they will lead you to the important information that you need to
know, without your having to ask, even if it is off topic from your original question.
Make sure to express your main concerns with the company, and see how they address your tough questions.
If they are losing money year over year, ask them how they intend to raise the necessary funds, and when they
are going to start bringing in some earnings. If a new competitor has risen up in their sector, ask them for
details of their plan to adapt to this new situation.
Listen especially hard for the underlying message that they are providing you with. Are they coming across like
a pushy salesperson, or are they confident and excited about the company's prospects?
Go a step further, and contact the investor relations department of the company's competitors. Make sure not to
confuse which individual contact-person you liked best with which company has the best prospects. Remove
emotion from the equation.
BEACON
Introduction
EQUITY RESEARCH
Prices in the financial markets move in trends, reflecting buyers that are more enthusiastic than sellers
and creating uptrends or bull markets; sellers that are more enthusiastic than buyers create
Introduction
downtrends or bear markets, a temporary period in which the enthusiasm between buyers and sellers
is roughly
in balance - often setting the stage for a reversal in trend. A reversal in trend does not
3ULFHVLQWKHQDQFLDOPDUNHWVPRYHLQWUHQGVUHHFWLQJEX\HUVWKDWDUHPRUHHQWKXVLDVWLFWKDQ
VHOOHUVDQGFUHDWLQJXSWUHQGVRUEXOOPDUNHWVVHOOHUVWKDWDUHPRUHHQWKXVLDVWLFWKDQEX\HUV
necessarily
mean that an uptrend will turn into a downtrend or vice-versa, it simply means that a
FUHDWH
GRZQWUHQGV
EHDU PDUNHWV
D WHPSRUDU\
SHULRG market,
LQ ZKLFK or
WKH
HQWKXVLDVP
EHWZHHQ market may
trending market
may beRU
transitioning
into
a consolidating
that
a consolidating
EX\HUV
DQG
VHOOHUV
LV
URXJKO\
LQ
EDODQFH
RIWHQ
VHWWLQJ
WKH
VWDJH
IRU
D
UHYHUVDO
LQ
WUHQG
be transitioning into a trending market.
$UHYHUVDOLQWUHQGGRHVQRWQHFHVVDULO\PHDQWKDWDQXSWUHQGZLOOWXUQLQWRDGRZQWUHQGRU
YLFHYHUVDLWVLPSO\PHDQVWKDWDWUHQGLQJPDUNHWPD\EHWUDQVLWLRQLQJLQWRDFRQVROLGDWLQJ
If a trader
can recognize some of the several common price patterns, he will be better positioned for a
PDUNHWRUWKDWDFRQVROLGDWLQJPDUNHWPD\EHWUDQVLWLRQLQJLQWRDWUHQGLQJPDUNHW
profitable move. However, it is critical to be able to discern the difference between a trend reversal that
results,IDWUDGHUFDQUHFRJQL]HVRPHRIWKHVHYHUDOFRPPRQSULFHSDWWHUQVKHZLOOEHEHWWHUSRVLWLRQHG
in a continuing or consolidation pattern and one that actually results in a reversal of prices. This
IRUDSURWDEOHPRYH+RZHYHULWLVFULWLFDOWREHDEOHWRGLVFHUQWKHGLIIHUHQFHEHWZHHQD
manual
will help the trader identify and differentiate between continuation patterns and reversal
WUHQGUHYHUVDOWKDWUHVXOWVLQDFRQWLQXLQJRUFRQVROLGDWLRQSDWWHUQDQGRQHWKDWDFWXDOO\UHVXOWV
patterns.
LQ D UHYHUVDO RI SULFHV7KLV PDQXDO ZLOO KHOS WKH WUDGHU LGHQWLI\ DQG GLIIHUHQWLDWH EHWZHHQ
FRQWLQXDWLRQSDWWHUQVDQGUHYHUVDOSDWWHUQV
Continuation Patterns
Continuation
Continuation
patterns arePatterns
price formations that imply a pause or consolidation in the prevailing trend.
The most common types are triangles, flags and pennants.
&RQWLQXDWLRQSDWWHUQVDUHSULFHIRUPDWLRQVWKDWLPSO\DSDXVHRUFRQVROLGDWLRQLQWKHSUHYDLOLQJ
WUHQG7KHPRVWFRPPRQW\SHVDUHWULDQJOHVDJVDQGSHQQDQWV
There are three types of triangle patterns: ascending, descending and broadening. While perhaps the
most common
all price
triangles
are
unfortunately
the least
reliable. The
ascending
7KHUH DUHofWKUHH
W\SHVpatterns,
RI WULDQJOH
SDWWHUQV
DVFHQGLQJ
GHVFHQGLQJ
DQG EURDGHQLQJ
:KLOH
SHUKDSVWKHPRVWFRPPRQRIDOOSULFHSDWWHUQVWULDQJOHVDUHXQIRUWXQDWHO\WKHOHDVWUHOLDEOH
triangle
is a sideways price pattern between two converging trend lines, in which the lower line is
The ascending
triangle
D VLGHZD\V
SDWWHUQ
EHWZHHQ
WZR FRQYHUJLQJ
WUHQG OLQHV LQ
rising while
the upper
line isLVflat.
This is SULFH
generally
a bullish
pattern
(see diagram).
ZKLFKWKHORZHUOLQHLVULVLQJZKLOHWKHXSSHUOLQHLVDW7KLVLVJHQHUDOO\DEXOOLVKSDWWHUQVHH
GLDJUDP
BEACON
www.BeaconEquity.com
BEACON
EQUITY RESEARCH
www.BeaconEquity.com
EQUITY RESEARCH
7KHQDOW\SHRIWULDQJOHLVNQRZQDVDbroadening formation%URDGHQLQJIRUPDWLRQVRFFXU
formation%URDGHQLQJIRUPDWLRQVRFFXU
The7KHQDOW\SHRIWULDQJOHLVNQRZQDVDbroadening
final
type of triangle is known as a broadening formation.
Broadening formations occur when a
ZKHQDVHULHVRIWKUHHRUPRUHSULFHXFWXDWLRQVZLGHQRXWLQVL]HVRWKDWSHDNVDQGWURXJKV
ZKHQDVHULHVRIWKUHHRUPRUHSULFHXFWXDWLRQVZLGHQRXWLQVL]HVRWKDWSHDNVDQGWURXJKV
series
of
three
or
more
price
fluctuations
widen
out
in
size
so
that
FDQEHFRQQHFWHGZLWKWZRGLYHUJLQJWUHQGOLQHVVHHGLDJUDPpeaks and troughs can be
FDQEHFRQQHFWHGZLWKWZRGLYHUJLQJWUHQGOLQHVVHHGLDJUDP
connected
with two diverging trend lines (see diagram).
BEACON
www.BeaconEquity.com
EQUITY RESEARCH
FlagsDUHDFRQWLQXDWLRQSULFHSDWWHUQJHQHUDOO\ODVWLQJOHVVWKDQWKUHHZHHNVUHVHPEOLQJD
SDUDOOHORJUDPWKDWVORSHVDJDLQVWWKHSUHYDLOLQJWUHQG$VWKHQDPHLPSOLHVWKLVSDWWHUQORRNV
Flags
are a continuation price pattern generally lasting less than three weeks, resembling a
OLNHDDJRQWKHFKDUW,WUHSUHVHQWVDTXLHWSDXVHDFFRPSDQLHGE\DWUHQGRIGHFOLQLQJYROXPH
parallelogram
that slopes against the prevailing trend. As the name implies, this pattern looks like a
WKDWLQWHUUXSWVDVKDUSDOPRVWYHUWLFDOULVHRUGHFOLQH,QWKHFDVHRIDULVLQJPDUNHWWKHDJ
flag
on the chart. It represents a quiet pause accompanied by a trend of declining volume that
LVXVXDOO\IRUPHGZLWKDVOLJKWGRZQZDUGWUHQGEXWLQDIDOOLQJPDUNHWLWKDVDVOLJKWXSZDUG
interrupts a sharp, almost vertical rise or decline. In the case of a rising market, the flag is usually
ELDV)ODJVPD\DOVREHSHUIHFWO\KRUL]RQWDO$VWKHDJLVFRPSOHWHGSULFHVEUHDNRXWLQWKH
formed
with a slight downward trend, but in a falling market, it has a slight upward bias. Flags may
VDPHGLUHFWLRQWKDWWKH\ZHUHPRYLQJLQSULRUWRLWVIRUPDWLRQ
also be perfectly horizontal. As the flag is completed, prices breakout in the same direction that they
were moving in prior to its formation.
,QDULVLQJPDUNHWWKLVW\SHRISDWWHUQXVXDOO\VHSDUDWHVWZRKDOYHVRIDQDOPRVWYHUWLFDOULVH
In9ROXPHLVQRUPDOO\H[WUHPHO\KHDY\MXVWEHIRUHWKHSRLQWDWZKLFKWKHDJIRUPDWLRQEHJLQV
a rising market, this type of pattern usually separates two halves of an almost vertical rise. Volume
is$VLWGHYHORSVYROXPHJUDGXDOO\GULHVWRDOPRVWQRWKLQJRQO\WRH[SORGHDVWKHSULFHZRUNV
normally extremely heavy just before the point at which the flag formation begins. As it develops,
LWVZD\RXWRIWKHFRPSOHWHGIRUPDWLRQ)ODJVFDQIRUPLQDSHULRGDVVKRUWDVYHGD\VRUDV
volume
gradually dries to almost nothing, only to explode as the price works its way out of the
ORQJDVWKUHHWRYHZHHNV(VVHQWLDOO\WKH\UHSUHVHQWDSHULRGRIFRQWUROOHGSURWWDNLQJLQD
completed
formation. Flags can form in a period as short as five days, or as long as three to five
ULVLQJPDUNHWVHHGLDJUDP
weeks.
Essentially, they represent a period of controlled profit taking in a rising market (see diagram).
Pennants, on the other hand, are flags with converging, rather than parallel, boundary lines. They
develop
under exactly the same circumstances as a flag and have similar characteristics. The
3HQQDQWVRQWKHRWKHUKDQGDUHDJVZLWKFRQYHUJLQJUDWKHUWKDQSDUDOOHOERXQGDU\OLQHV
difference
is that this type of consolidation formation is constructed from two converging trend lines. In
7KH\GHYHORSXQGHUH[DFWO\WKHVDPHFLUFXPVWDQFHVDVDDJDQGKDYHVLPLODUFKDUDFWHULVWLFV
a7KHGLIIHUHQFHLVWKDWWKLVW\SHRIFRQVROLGDWLRQIRUPDWLRQLVFRQVWUXFWHGIURPWZRFRQYHUJLQJ
sense, the flag corresponds to a rectangle, and the pennant to a triangle, because a pennant is, in
effect,
very small
triangleWKH
(see
diagram).
WUHQGaOLQHV
,Q D VHQVH
DJ
FRUUHVSRQGV WR D UHFWDQJOH DQG WKH SHQQDQW WR D WULDQJOH
EHFDXVHDSHQQDQWLVLQHIIHFWDYHU\VPDOOWULDQJOHVHHGLDJUDP
BEACON
BEACON
EQUITY RESEARCH
www.BeaconEquity.com
www.BeaconEquity.com
EQUITY RESEARCH
Wedges
DUH FKDUW
IRUPDWLRQV
LQ ZKLFK
WKH SULFH
XFWXDWLRQV
DUH FRQQHG
ZLWKLQ ZLWKLQ
FRQYHUJLQJ
Wedges
DUH FKDUW
IRUPDWLRQV
LQ ZKLFK
WKH SULFH
XFWXDWLRQV
DUH FRQQHG
FRQYHUJLQJ
Wedges
are chart formations in which the price fluctuations are confined within converging straight
VWUDLJKWRUSUDFWLFDOO\VWUDLJKWOLQHV$ZHGJHLVYHU\VLPLODUWRDWULDQJOHLQWKDWWZRFRQYHUJLQJ
VWUDLJKWRUSUDFWLFDOO\VWUDLJKWOLQHV$ZHGJHLVYHU\VLPLODUWRDWULDQJOHLQWKDWWZRFRQYHUJLQJ
OLQHV
FDQstraight)
EH FRQVWUXFWHG
D VHULHV
RI SHDNV
DQGto
WURXJKV
+RZHYHU
ZKHUHDV
D WULDQJOH
OLQHV
FDQ
EH FRQVWUXFWHG
IURP
D
RI SHDNV
DQG
WURXJKV
D WULDQJOH
(or practically
lines. IURP
A wedge
isVHULHV
very
similar
a triangle
in+RZHYHU
that
two ZKHUHDV
converging
lines can
FRQVLVWV
RI
RQH
ULVLQJ
DQG
RQH
IDOOLQJ
OLQH
RU
RQH
KRUL]RQWDO
OLQH
WKH
FRQYHUJLQJ
OLQHV
LQ
D
FRQVLVWV
RI
RQH
ULVLQJ
DQG
RQH
IDOOLQJ
OLQH
RU
RQH
KRUL]RQWDO
OLQH
WKH
FRQYHUJLQJ
OLQHV
be constructed from a series of peaks and troughs. However, whereas a triangle consistsLQ
ofDone
ZHGJHERWKPRYHLQWKHVDPHGLUHFWLRQ$IDOOLQJZHGJHUHSUHVHQWVDWHPSRUDU\LQWHUUXSWLRQ
ZHGJHERWKPRYHLQWKHVDPHGLUHFWLRQ$IDOOLQJZHGJHUHSUHVHQWVDWHPSRUDU\LQWHUUXSWLRQ
rising RIDULVLQJWUHQGDQGDULVLQJZHGJHLVDWHPSRUDU\LQWHUUXSWLRQRIDIDOOLQJWUHQG,WLVQRUPDO
and one falling line, or one horizontal line, the converging lines in a wedge both move in the
RIDULVLQJWUHQGDQGDULVLQJZHGJHLVDWHPSRUDU\LQWHUUXSWLRQRIDIDOOLQJWUHQG,WLVQRUPDO
same IRUYROXPHWRFRQWUDFWGXULQJWKHIRUPDWLRQRIERWKZHGJHV6LQFHZHGJHVFDQWDNHDQ\ZKHUH
direction. A falling wedge represents a temporary interruption of a rising trend, and a rising
IRUYROXPHWRFRQWUDFWGXULQJWKHIRUPDWLRQRIERWKZHGJHV6LQFHZHGJHVFDQWDNHDQ\ZKHUH
wedgeIURPWZRWRQLQHZHHNVWRFRPSOHWHWKH\VRPHWLPHVRFFXURQZHHNO\FKDUWVEXWDUHWRREULHI
is IURPWZRWRQLQHZHHNVWRFRPSOHWHWKH\VRPHWLPHVRFFXURQZHHNO\FKDUWVEXWDUHWRREULHI
a temporary interruption of a falling trend. It is normal for volume to contract during the
WRDSSHDURQPRQWKO\FKDUWV5LVLQJZHGJHVDUHIDLUO\FRPPRQDVEHDUPDUNHWUDOOLHV)ROORZLQJ
formation
of both wedges. Since wedges can take anywhere from two to nine weeks to complete,
WRDSSHDURQPRQWKO\FKDUWV5LVLQJZHGJHVDUHIDLUO\FRPPRQDVEHDUPDUNHWUDOOLHV)ROORZLQJ
WKHLUFRPSOHWLRQSULFHVXVXDOO\EUHDNYHU\VKDUSO\HVSHFLDOO\LIYROXPHSLFNVXSQRWLFHDEO\RQ
they sometimes
occur on weekly charts but are too brief to appear on monthly charts. Rising
WKHLUFRPSOHWLRQSULFHVXVXDOO\EUHDNYHU\VKDUSO\HVSHFLDOO\LIYROXPHSLFNVXSQRWLFHDEO\RQ
WKHGRZQVLGHVHHGLDJUDP
WKHGRZQVLGHVHHGLDJUDP
wedges are
fairly common as bear market rallies. Following their completion, prices usually break
very sharply, especially if volume picks up noticeably on the downside (see diagram).
BEACON
EQUITY RESEARCH
BEACON
www.BeaconEquity.com
www.BeaconEquity.com
EQUITY RESEARCH
A Runaway Gap is a relatively wide gap in prices which occurs in an advance or decline gathering
A Runaway GapLVDUHODWLYHO\ZLGHJDSLQSULFHVZKLFKRFFXUVLQDQDGYDQFHRUGHFOLQHJDWKHULQJ
momentum. It is
also called,WaLVmeasuring
gap since it frequently occurs at just about the halfway point
PRPHQWXP
DOVR FDOOHG D PHDVXULQJ JDS VLQFH LW IUHTXHQWO\ RFFXUV DW MXVW DERXW WKH
A Runaway GapLVDUHODWLYHO\ZLGHJDSLQSULFHVZKLFKRFFXUVLQDQDGYDQFHRUGHFOLQHJDWKHULQJ
between the breakout,
which
started
the
move
and the reversal day, which calls an end to it. The
KDOIZD\SRLQWEHWZHHQWKHEUHDNRXWZKLFKVWDUWHGWKHPRYHDQGWKHUHYHUVDOGD\ZKLFKFDOOV
PRPHQWXP
,W LV DOVR FDOOHG D PHDVXULQJ JDS VLQFH LW IUHTXHQWO\ RFFXUV DW MXVW DERXW WKH
runaway gapKDOIZD\SRLQWEHWZHHQWKHEUHDNRXWZKLFKVWDUWHGWKHPRYHDQGWKHUHYHUVDOGD\ZKLFKFDOOV
occurs
a straight-line
advance
or decline
when priceDGYDQFH
quotations
are moving
rapidly
DQ HQGduring
WR LW 7KH
UXQDZD\ JDS
RFFXUV GXULQJ
D VWUDLJKWOLQH
RU GHFOLQH
ZKHQ SULFH
and emotionsDQ
are
running
high.
Either JDS
it is RFFXUV
closedGXULQJ
very quickly,
such as
within RU
a day
or so,
or tends
TXRWDWLRQVDUHPRYLQJUDSLGO\DQGHPRWLRQVDUHUXQQLQJKLJK(LWKHULWLVFORVHGYHU\TXLFNO\
HQG
WR LW 7KH
UXQDZD\
D VWUDLJKWOLQH
DGYDQFH
GHFOLQH
ZKHQ
SULFH to
remain open TXRWDWLRQVDUHPRYLQJUDSLGO\DQGHPRWLRQVDUHUXQQLQJKLJK(LWKHULWLVFORVHGYHU\TXLFNO\
forVXFKDVZLWKLQDGD\RUVRRUWHQGVWRUHPDLQRSHQIRUPXFKORQJHUSHULRGVDQGLVQRWJHQHUDOO\
much longer periods and is not generally closed until the market makes a major or
FORVHG
WKH PDUNHW
PDNHVto
D PDMRU
RU LQWHUPHGLDWH
VZLQJ
LQresponsible
WKH RSSRVLWHfor
GLUHFWLRQ
WRThis
intermediate VXFKDVZLWKLQDGD\RUVRRUWHQGVWRUHPDLQRSHQIRUPXFKORQJHUSHULRGVDQGLVQRWJHQHUDOO\
swing
in XQWLO
the opposite
direction
the price
movement that
was
the gap.
WKHSULFHPRYHPHQWWKDWZDVUHVSRQVLEOHIRUWKHJDS7KLVW\SHRIJDSRIWHQRFFXUVKDOIZD\
FORVHG
XQWLO WKH
PDUNHW
PDNHV a
D previous
PDMRU RU LQWHUPHGLDWH
LQ WKH RSSRVLWH
WR (see
type of gap often
occurs
halfway
between
breakout andVZLQJ
the ultimate
durationGLUHFWLRQ
of the move
EHWZHHQDSUHYLRXVEUHDNRXWDQGWKHXOWLPDWHGXUDWLRQRIWKHPRYHVHHGLDJUDP
WKHSULFHPRYHPHQWWKDWZDVUHVSRQVLEOHIRUWKHJDS7KLVW\SHRIJDSRIWHQRFFXUVKDOIZD\
diagram).
EHWZHHQDSUHYLRXVEUHDNRXWDQGWKHXOWLPDWHGXUDWLRQRIWKHPRYHVHHGLDJUDP
Reversal Patterns
Reversal
Patterns
Reversal Patterns
lower volume. A rally back through the apex of the intervening rally confirms the reversal. More than a
month should separate the two bottoms (see diagram).
5
5
BEACON
www.BeaconEquity.com
EQUITY RESEARCH
BEACON
www.BeaconEquity.com
EQUITY RESEARCH
V-BottomsDUHVXGGHQUHYHUVDOVWKDWWDNHSODFHZLWKOLWWOHRUQRZDUQLQJ$VXGGHQSULFHGURS
RQKHDY\YROXPHLVWKHRQO\WHOOWDOHVLJQ8QIRUWXQDWHO\WKHVHVXGGHQWXUQVDUHKDUGWRVSRWLQ
V-Bottoms
are sudden reversals that take place with little or no warning. A sudden price drop on heavy
V-BottomsDUHVXGGHQUHYHUVDOVWKDWWDNHSODFHZLWKOLWWOHRUQRZDUQLQJ$VXGGHQSULFHGURS
volume DGYDQFHVHHGLDJUDP
is the only telltale sign. Unfortunately, these sudden turns are hard to spot in advance (see
diagram).RQKHDY\YROXPHLVWKHRQO\WHOOWDOHVLJQ8QIRUWXQDWHO\WKHVHVXGGHQWXUQVDUHKDUGWRVSRWLQ
DGYDQFHVHHGLDJUDP
Saucer
Bottoms DUH FRQVWUXFWHG E\ GUDZLQJ D FLUFXODU OLQH XQGHU WKH ORZV ZKLFK URXJKO\
DSSUR[LPDWHVDQHORQJDWHGRUVDXFHUVKDSHGOHWWHU8$VWKHSULFHGULIWVWRZDUGWKHORZ
Saucer Bottoms are constructed by drawing a circular line under the lows, which roughly approximates
Saucer
Bottoms
DUH FRQVWUXFWHG
E\the
GUDZLQJ
FLUFXODU
OLQH
WKH of
ORZV
ZKLFK URXJKO\
SRLQWRIWKHVDXFHUDQGLQYHVWRUVORVHLQWHUHVWGRZQZDUGPRPHQWXPGLVVLSDWHV7KLVODFNRI
an elongated
or saucer
- shaped
letter U. As
price D
drifts
toward
theXQGHU
low point
the saucer
and
DSSUR[LPDWHVDQHORQJDWHGRUVDXFHUVKDSHGOHWWHU8$VWKHSULFHGULIWVWRZDUGWKHORZ
LQWHUHVWLVDOVRFKDUDFWHUL]HGE\WKHYROXPHOHYHOZKLFKDOPRVWGULHVXSDWWKHWLPHWKHSULFHLV
investors
lose interest, downward momentum dissipates. This lack of interest is also characterized by the
SRLQWRIWKHVDXFHUDQGLQYHVWRUVORVHLQWHUHVWGRZQZDUGPRPHQWXPGLVVLSDWHV7KLVODFNRI
UHDFKLQJLWVORZSRLQW*UDGXDOO\ERWKSULFHDQGYROXPHSLFNXSXQWLOHYHQWXDOO\HDFKH[SORGH
volume level, which almost dries up at the time the price is reaching its low point. Gradually, both price
LQWHUHVWLVDOVRFKDUDFWHUL]HGE\WKHYROXPHOHYHOZKLFKDOPRVWGULHVXSDWWKHWLPHWKHSULFHLV
LQWRDQDOPRVWH[SRQHQWLDOSDWWHUQVHHGLDJUDP
and volume
pick up until eventually each explode into an almost exponential pattern (see diagram).
UHDFKLQJLWVORZSRLQW*UDGXDOO\ERWKSULFHDQGYROXPHSLFNXSXQWLOHYHQWXDOO\HDFKH[SORGH
LQWRDQDOPRVWH[SRQHQWLDOSDWWHUQVHHGLDJUDP
6
6
BEACON
www.BeaconEquity.com
EQUITY RESEARCH
HeadShoulders
and Shoulders
DUH
WKHknown
EHVW NQRZQ
WKH UHYHUVDO
SDWWHUQV
$W D PDUNHW
WRS
WKUHH
Head and
are the
best
of the RI
reversal
patterns.
At a market
top, three
prominent
SURPLQHQWSHDNVDUHIRUPHGZLWKWKHPLGGOHSHDNRUKHDGVOLJKWO\KLJKHUWKDQWKHWZRRWKHU
peaks are formed with the middle peak (or head) slightly higher than the two other peaks (shoulders).
SHDNV VKRXOGHUV :KHQ WKH WUHQG OLQH QHFNOLQH FRQQHFWLQJ WKH WZR LQWHUYHQLQJ WURXJKV LV
When the trend line (neckline) connecting the two intervening troughs is broken, the pattern is complete.
EURNHQWKHSDWWHUQLVFRPSOHWH$ERWWRPSDWWHUQLVDPLUURULPDJHRIDWRSDQGLVFDOOHGDQ
A bottom pattern is a mirror image of a top and is called an inverse head and shoulders (see diagram).
LQYHUVHKHDGDQGVKRXOGHUVVHHGLDJUDP
BEACON
www.BeaconEquity.com
EQUITY RESEARCH
BEACON
www.BeaconEquity.com
RESEARCH
BreakawayEQUITY
and Exhaustive
GapsDUHVSDFHVRQWKHFKDUWZKHUHQRWUDGLQJKDVWDNHQSODFH$Q
XSJDSLVIRUPHGZKHQWKHORZHVWSULFHRQDWUDGLQJGD\LVKLJKHUWKDQWKHKLJKHVWKLJKRIWKH
SUHYLRXVGD\$GRZQJDSLVIRUPHGZKHQWKHKLJKHVWSULFHRQDGD\LVORZHUWKDQWKHORZHVW
Breakaway and Exhaustive GapsDUHVSDFHVRQWKHFKDUWZKHUHQRWUDGLQJKDVWDNHQSODFH$Q
Breakaway
and Exhaustive Gaps are spaces on the chart where no trading has taken place. An up gap
SULFHRIWKHSULRUGD\$QXSJDSLVXVXDOO\DVLJQRIPDUNHWVWUHQJWKZKLOHDGRZQJDSLVDVLJQ
XSJDSLVIRUPHGZKHQWKHORZHVWSULFHRQDWUDGLQJGD\LVKLJKHUWKDQWKHKLJKHVWKLJKRIWKH
is formed
when
the lowest price on a trading day is higher than the highest high of the previous day. A
RIPDUNHWZHDNQHVV
SUHYLRXVGD\$GRZQJDSLVIRUPHGZKHQWKHKLJKHVWSULFHRQDGD\LVORZHUWKDQWKHORZHVW
down gap isSULFHRIWKHSULRUGD\$QXSJDSLVXVXDOO\DVLJQRIPDUNHWVWUHQJWKZKLOHDGRZQJDSLVDVLJQ
formed when the highest price on a day is lower than the lowest price of the prior day. An up
gap is
usually
a sign
of market strength, while a down gap is a sign of market weakness.
A Breakaway
GapIRUPVRQWKHFRPSOHWLRQRIDQLPSRUWDQWSULFHSDWWHUQDQGXVXDOO\VLJQDOVWKH
RIPDUNHWZHDNQHVV
EHJLQQLQJRIDQLPSRUWDQWSULFHPRYHVHHGLDJUDP
A Breakaway
Gap forms
on the completion of an important price pattern and usually signals the
A Breakaway
GapIRUPVRQWKHFRPSOHWLRQRIDQLPSRUWDQWSULFHSDWWHUQDQGXVXDOO\VLJQDOVWKH
EHJLQQLQJRIDQLPSRUWDQWSULFHPRYHVHHGLDJUDP
beginning of an important price move (see diagram).
Conversely,
an Exhaustion GapGapRFFXUVDWWKHHQGRIDQLPSRUWDQWWUHQGDQGVLJQDOVWKDWWKH
occurs
at the end of an important trend, and signals that the trend is
&RQYHUVHO\DQExhaustion
&RQYHUVHO\DQExhaustion
GapRFFXUVDWWKHHQGRIDQLPSRUWDQWWUHQGDQGVLJQDOVWKDWWKH
ending.
The
price
gaps
are
relatively
wide
and are quickly closed, most often within two to five days,
WUHQGLVHQGLQJ7KHSULFHJDSVDUHUHODWLYHO\ZLGHDQGDUHTXLFNO\FORVHGPRVWRIWHQZLWKLQ
WUHQGLVHQGLQJ7KHSULFHJDSVDUHUHODWLYHO\ZLGHDQGDUHTXLFNO\FORVHGPRVWRIWHQZLWKLQ
which
helpsWZRWRYHGD\VZKLFKKHOSVWRGLVWLQJXLVKWKHPIURPUXQDZD\JDSVZKLFKDUHQRWXVXDOO\
to distinguish them from runaway gaps, which are not usually covered for a considerable
WZRWRYHGD\VZKLFKKHOSVWRGLVWLQJXLVKWKHPIURPUXQDZD\JDSVZKLFKDUHQRWXVXDOO\
FRYHUHGIRUDFRQVLGHUDEOHOHQJWKRIWLPHVHHGLDJUDP
length
of time (see diagram).
FRYHUHGIRUDFRQVLGHUDEOHOHQJWKRIWLPHVHHGLDJUDP
BEACON
www.BeaconEquity.com
EQUITY RESEARCH
This free ebook is a redistribution and in no way do we claim ownership over it's content, nor did we charge for
this material.