I want to talk to you about the “pendulum theory”. The pendulum theory is an old theory that we developed on Wall Street when a group of market makers would get together after hours for a snack without solid food. (Liver damage was an occupational hazard for market makers, as these academic discussions began about half an hour after the market closed and usually lasted until the bar closed.)
The pendulum theory says that the more the action swings in one direction, the more it will swing in the other. If the stock goes too high, it will go too low.
On the other hand, there are plenty of quiet stocks that don’t swing much, but they are mostly not penny stocks. If these quiet actions don’t swing much one way, they won’t swing much the other way.
The underlying viability of this theory is that stocks have certain financial and structural factors that determine how they move.
Small companies are generally more volatile than large ones because less buying or less news will move the stock more.
If there is a relatively small number of shares in public hands, ie a small amount of “float”, the stock will tend to swing more wildly as the amount of supply that can stop any buying coming into the stock is less. (Note that the float may change over time due to additions from people selling shares under Rule 144 or other sources.)
If the company is in profit and its value is determined largely on those profits and a small profit margin, any expansion in the profit margin will produce a relatively large change in profits, and thus in price. For example, one company has a 1% markup and another has a 10% markup. If both increase their profit margins by 1%, the first company has doubled its profits but the second only has a 10% increase.
In the case of penny stocks, their price is often determined by the effort and care that goes into informing the investing public. The old saying “stocks are not bought, they are sold” applies. That is, there are not many people looking at small companies to buy shares. Rather, companies have to work hard to get people to buy their stock.
Another determining factor in the volatility of stocks is the presence of possible news. If the company, like many of the companies we review here, is waiting for a deal, plenty of news gets the stock moving fast.
Lastly, an attack by predatory short sellers can increase volatility.
Another aspect of the pendulum theory is momentum. Momentum simply means that penny stocks in general, and reverse merger stocks in particular, when they are on the move tend to stay on the move. They are one-way streets for a while, until the pendulum swings.
With a volatile stock, the pendulum swings “too far” up, then too far in, then too far up. So a stock can start to become less and less volatile as time goes on. Therefore, there may be less and less momentum in stock movements.
This is typical of some of these stocks, the momentum makes them go too far and they are very volatile and treacherous to trade. But it makes it more fun and sometimes more profitable. Travel at your own risk! As always, we tell you this is a risky investment, don’t use more money than you can afford to lose and do your own homework. Include in your analysis some idea of the float and other factors that will affect the stock’s volatility. You can find more data in my books, How to Find a Home Run Stock and How to Pick Hot Reverse Melt Penny Stocks.
