More Misconceptions Hurting Small Accounts Plus Small Caps That Work
Last time we talked about some important tips for growing a small account quickly through short-term swing trading.
Today we will discuss more common limiting beliefs and trading misconceptions holding a lot of traders back plus go over what a great trading setup looks like on a lower priced stock.
Limiting Belief #9 – My Guy/Gal is not in Office. So the Market is Doomed
Warren Buffet once said its very important to maintain a nonpolitical approach to investment decisions. This is a great point.
Yes, if the candidate that is pro economic growth, low taxes and wants to reduce regulation wins, its generally good for the economy and market. If this candidate is likely to win, the market tends to run up into the election and then correct somewhat the following year or soon after that.
If the other candidate wins, the market usually sells off into the election but then starts to recover the next year historically. This is because the market takes times to completely digest the changes implemented by a new administration and then retraces the following year once changes are implemented or passed by congress and signed by the President which tend not to be as bullish or bearish as many investors think. Politics exaggerates everything.
If taxes go down a bit or go up a bit, if regulation increases somewhat or decreases somewhat, or other changes are implemented that are bullish or bearish, the market will digest the news and eventually continue on its longer-term trend. Or, move lower into a recession once we see definite signs one is coming.
Just after the peak of the recession when everything looks the worst, the market tends to rally strongly as it anticipates the start of the next economic cycle.
So forget politics when swing trading and focus on the market action and trend. And, yes, there will be plenty of bearish divergences that often last many months or years before the trend changes to the downside as we just saw with many of the biggest winners over the past year. SMCI was bearish divergence before going up 1,500% after we featured it early last year for example.
When will the trend change happen? When it happens.
We went bullish in late 2022 because the market signals were bullish including a 1-2-3 trend change in the market indices. Look at past blog posts and you will see what these trend changes are.
We were bullish in May of last year because of the narrow consolidation near the recent highs that went on long enough with a now rising 200 day moving average among other signs.
The price action in the overall market was bullish and we are swing trading with shorter hold times. There is no need to predict what happens a few months from now or the years after. We take advantage of the trend to make money as swing traders whatever that trend is at the time. We would rather pay more taxes on profits than no taxes because the profit is gone by the time we sold.
We were bullish in late October of last year because the problem that drove the correction from August to late October was being alleviated by a new announcement made by the treasury. This, combined with the bullish signal in the market, was telling us to go long early in a new rally. This is why we featured PINS, ANET and many other big winners early in a new rally.
Limiting Belief #10 – A Noted Memester Just Made a Lot of Money so I Need to do What They do
This is the most important section for newer traders or anyone trying to make money on meme stocks, lower priced stocks or penny stocks.
Over a recent weekend, a noted memester posted that they just entered a big position on GME with both stock and calls.
On Monday morning, the crowd who follows the memester likely bought a bunch of stock and calls on GME. The stock gapped a lot higher and then fell sharply most of the day.
Those who bought the calls right after the memester post are down huge on their position.
In fact, they lost so much that they may as well keep the calls because they have lost so much value. Even if the stock is flat over that timeframe, the calls could be down a lot over the past week – especially now that the earnings report is behind us.
Now here is the math behind trading that few understand that are new to the game. Lets say you cut the losses when down 40% and then make 60% on your next trade.
So, as an example, you start with a thousand dollars and you lost 40%. So now you have $600 left.
Lets say you knock it out of the park and you make 60% on your next trade. You lost 40% but then made 60% so you must be making money, right?
Wrong. A 60% profit on what is left takes you back to just $996. So your average profit is 10% (60% profit minus 40% loss divided by 2 = 10%/trade) yet you are losing money.
Now lets say you go for a 10% profit with a 7% stop on a higher quality stock in a multi-year uptrend. With just a 50/50 win rate, you are still making money overall. The 7% loss would turn $1,000 into $930 and the 10% profit would take it to over $1,023.
The kicker is that the win rate on meme stocks, penny stocks and other stocks in long-term downtrends or with a declining business is lower than on higher quality growth and other great stocks in long-term uptrends. Every back-test and our own 15 years trading experience shows this over and over. The better bet is to short but that is dangerous on these stocks due to the unlimited downside risk of shorting.
If you go long, you have the disaster scenario of an overnight capital raise or trading halt with a big gap lower that is extremely rare on better quality stocks with growing businesses within 30% of all-time highs unless you hold through earnings.
In fact, going long stocks like GME or other low quality stocks in secular decline, over and over, almost guarantees an account blowup. This is why all the penny stock traders talk about how they blew up their account multiple times when they started.
Later, after they create a big following online, they suddenly become great penny stock traders. Hmmmm is what you should be thinking.
The problem for regular traders, their followers, is that they get in much higher and get out much lower than the person pumping the stock. Last week was another example of this. So, again, if you cannot push the stock up yourself, then you are likely doomed to an ever-declining account when trading low quality stocks and options due to their long-term trend and time decay in the case of options unless you short which, again, is dangerous with these stocks.
Some would argue that you can just take a much smaller position. So instead of using $1,000, just take a $100 position.
Then why trade stocks with a lower win rate in the first place if you have to dramatically cut the position size to effectively trade it? Trade it with a 4% stop and the win rate goes a LOT lower on these low quality stocks in secular decline well off the highs.
Now contrast this with NVDA which we featured recently breaking out of a high tight flag into new highs right after earnings. The stock surged 20% higher quickly while again holding a 1.5% stop-loss below the ideal technical entry point which it has done for us and customers many times before.
NVDA was by far the better trade on a stock whose underlying business is on fire and likely has a great future. Another stock, SMTC, hit our 4.5% stop due to a sudden firing of the CEO after earnings but overall we made a lot of money on the 2 trades just by being a disciplined, well planned trader on a strategy with a higher win rate and lower risk on stocks with improving results and outlook.
A Better Approach to Trading Lower Priced Stocks
Now I don’t want to seem like I’m hating on lower priced stocks. There are actually some that are good trading ideas without being a very low probability turnaround story where the turnaround is showing no signs of happening as in the case of GME no matter how smart the new CEO is.
Here is a good example of what a good trading setup looks like on a daily chart:
Charts courtesy of StockCharts.com
Here is AMSC when we alerted customers to it on May 29th. The 200 day moving average is not shown on the chart but its been rising for many months as the stock forms a bullish chart pattern just below 52-weeks highs. This is a good sign.
The company then reported excellent numbers after hours. A top tier beat and raise quarter which was causing a large gap after hours. Another good sign.
The stock opened the next day, reached our entry trigger price quickly and then soared 30% over the next week while holding the higher levels. This is key.
A stock like GME that suddenly gaps up 50% and then gaps down 30% and has wild, sudden unpredictable (because its being manipulated instead of being accumulated by large funds) upswings and downswings with plenty of halts does us no good as swing traders. You can short them with great timing, but this is risky.
But AMSC had great results, a good outlook, a long-term uptrend, bullish consolidation pattern and then reached a great technical entry point right after terrific news. This is what we look for in a lower priced stock. Its unusual but they are out there. Not coincidentally, its also a great company where management is working hard and actually producing great results for customers and shareholders.
ROVR is another good example of a lower priced stock we featured late last year. This stock also had a bullish long-term uptrend, bullish consolidation and reached our entry point on good news. It held a tight stop below the technical entry point before hitting the target. This is key when trading. Stocks in long-term uptrends tend to hold tighter stop-losses.
Yes, You can Grow a Small Account Quickly with a Great Strategy on Better Quality Stocks
So there you have it. 2 example trades on NVDA and AMSC that would be great for building a small account quickly.
If you can average 3% per trade, averaging the wins and losses, while using a tight stop-loss, you could do extremely well trading over 100 trades if you want to up your risk with large position sizes without even using margin. You have a lot better shot than trading meme stocks and penny stocks.
The first place to start to develop a great strategy, practice on a free simulator first and then start with a small account.
Here is the example again of what happens to a small account with very aggressive position sizing while using a 2.5% to 4% stop-loss while averaging a little over 6% profit per trade (averaging winners and losers). Again, its going to be flat to lower for a while and then move strongly higher for other periods if you become a really good swing trader. This is typical when looking at the equity curves of the best traders who like to take aggressive position sizes. A better example of a more typical equity curve with aggressive position sizing is here.
Certainly not easy but possible and we just gave a couple examples of the types of trades that could possibly average you 6% per trade while using a tight stop once you become really good at this during a bull market. Again, you cannot let your losses run when trading. Know where you will stop out ahead of time on each trade.
The 2 trades mentioned above also hit a 7% to 14% profit very quickly without pulling back more than 1.5% below the technical entry point first which is also key because we need a tight stop and also want to get into the next trade to quickly compound. The high tight flags that meet the course rules and the top tier earnings gap trades in the earnings eruptions strategy are 2 great strategies to use. Typical high tight flag breakouts are not going to do it.
If you average 3% per trade, it takes about 120 trades to go from $3,000 to over $100,000 while using a tight stop with aggressive position sizing using a tight 2.5% to 4% stop. 200 trades to reach a million when compounding the account. So why trade stocks where the odds are against you?
The key is to learn a great strategy on better quality stocks, get your stats up over time through reviewing your trades, clean up mistakes and avoid going long in corrections and bear markets or be a lot more selective in which trades you take.
Limiting Belief #11 – I have a Larger Account so I Should Just Jump in with a New Strategy with Aggressive Position Sizing Because I’m Awesome
Uh… no. You want to start on a simulator and test your strategy first and fine tune it and clean up mistakes (we all make them) before going on a live account. Again, you can give a great trader $10,000 and they can turn it into $100,000 fairly quickly. You can give a newer trader $100,000 and they can turn it into $10,000 fairly quickly – especially with penny stocks, options or meme stocks.
A good question to ask yourself is “How can I average 3% per trade (averaging wins and losses) with an average hold time of 2 days or less while using a 2.5% to 4% stop-loss while not affecting my career?” Well, the top tier earnings gap trades mentioned in the earnings gap course and high tight flag breakouts that meet our course rules can do it.
In fact, the latest back-test on the high tight flag breakouts that met the course rules the morning before the breakout in 2023 averaged nearly 5% per trade while just going for the first target with a 4% stop. The time in the trade averaged about 2 days. We are seeing about 3 per month right now. More once the IPO market re-opens fully.
No guarantee, obviously, but it at least gives you a shot over low quality stocks where the stock price or business is in a long-term decline that are destined to take your account if you are not able to move the stock yourself. Again, you cannot fight math. Math always wins. Too much volatility, wild unpredictable swings, and no fundamental support for the stock leads to poor results over time in our experience.
I really hate to see so many people losing money on meme and penny stocks where the odds are stacked against them. Hopefully, this reaches the people it needs to reach. Share it with anyone sold on meme or penny stocks.
In the next blog post we will go over another great swing trading strategy to use to build a small account quickly without lowering your chance of success by using options, margin, forex, meme or penny stocks. For those who want to take the risk with a small account and give it a shot.
Creating Your Own Winning Trading Plan
Our Top 2 Swing Trading Opportunities for the Weeks Ahead
