Two of the biggest gainers in the market yesterday were both running on the same news…
Judging by the price action and jump in their stock prices, you might think this is good news…
But this news doesn’t change anything about the company.
It’s not like another news catalyst like good earnings, or news of a new drug passing trials. So why are these stocks having such huge gains?
I’ll explain below and share how I prefer to trade reverse stock splits…
Understanding Reverse Splits
Most reverse splits occur in stocks listed on the NASDAQ exchange.
That’s because the NASDAQ requires listed stocks to maintain a share price of $1 or more to stay listed on their exchange.
This rule pushes companies trading below $1 to perform reverse splits to avoid getting kicked down to the Over-The-Counter (OTC) markets.
Here’s how they work…
The Mechanics of Reverse Splits
Reverse stock splits aim to increase the stock price without altering the company’s market capitalization. Market capitalization represents the total value of a company.
For example, if a $1 stock has one million shares outstanding, its market cap is $1 million.
If they decide to do a 10-for-one reverse split, the number of outstanding shares drops to 100,000, and the stock’s price jumps to $10.
But here’s the key: the market cap remains $1 million.
In essence, it’s a paper shuffle that doesn’t change the company’s value, it just changes the number of shares available and the price.
Trading Opportunities with Reverse Splits
Now, let’s see if you can potentially profit from reverse splits…
The recent rise in stock prices like PIXY and SPRC yesterday shows you can profit from news that a company is doing a reverse stock split.
But is it a good edge and strategy?
Axcella Health Inc. (NASDAQ: AXLA) recently announced it was doing a reverse stock split…
And the stock plummeted after climbing for weeks on news of its long COVID treatment.
So while some stocks might spike on the news, I prefer a different approach to trading reverse splits…
How I Approach Reverse Stock Splits
The way I prefer to play them is to wait for the company to complete the reverse split, then I like to look for a news catalyst.
After a stock does a reverse split it has a low float, and a news catalyst can bring in buyers and send it soaring.
Buying a stock before it does a reverse split makes no sense to me…
Most traders think they’ll make money when the split completes. But the value of your position doesn’t change. Just the price of each share and the number of shares you own changes.
I hope this clears up some of the misconceptions about reverse stock splits.
And using my strategy for reverse stocks splits means PIXY and SPRC could be on watch over the next few weeks for company news.
Since good news that relates to a company’s actual business has more potential to spike a stock — especially once it has a low float.
That’s just my approach. You can do what you want.
But if you want to approach trading like a business and as a professional, you have to learn why companies do things like reverse splits.
And you have to stack the odds in your favor for any trading plan you make.
I can help you during my live training sessions — StocksToTrade has a whole team of presenters showing you how to find hot stocks, make watchlists and trade plans, and execute using top tech tools.
Have a great day everyone. See you back here tomorrow.
Lead Trainer, StocksToTrade