Don’t Be Fooled By These Trades

One of my top pieces of advice for traders is to learn the patterns!

Learn the patterns, learn the patterns, learn the patterns…

But you must know how to correctly identify a usable pattern before you add it to your trading strategy. 

That’s why you must also remember this advice: One outlying trade does not make a consistently repeatable strategy.

I bring this up because it’s fresh on my mind. It’s one of the things I discussed yesterday in my Premarket Prep.

In fact, I go over tons of strategies every morning in my Premarket Prep…And I do the same during my live Daily Double Down webinar at 12 pm Eastern…

Want access to two other daily webinars, plus our proprietary trading tools and more? Subscribe to Daily Income Trader today.

Back to consistent, repeatable strategies…

I mean, it’s great when a trade works and you make money, but you need to track your data to know if that price action is going to work in your favor most of the time. 

If 99 times out of 100, the outcome isn’t the same, it’s NOT a repeatable pattern. 

If it happens once every six months, it’s NOT a repeatable pattern.

These are outliers…You can pat yourself on the back and feel lucky that the play worked for you that one time.

In Premarket Prep, I brought up two examples of trades that look like repeatable patterns on the surface…

But looks can be deceiving.  

For example, Faraday Future Intelligent Electric Inc. (NASDAQ: FFIE) is a penny stock that had a beautiful gap up in May… but then it died. 

And most of the time, this is what happens after a penny stock gaps up. It’s good if you can catch the pop but it’s not something you can rely on. It’s not repeatable.

There’s another type of situation that will show up and 99 out of 100 times, it does not play out in your favor.

But yes, there is that one time you make a ton of money…

And boy, does that make it seem like you should trade it again the next time it comes around.

Don’t be fooled.

Besides the example I mentioned earlier, another type of setup that you should never consider a repeatable pattern are day-one reverse splits. 

To be clear, I’m not saying that no one should ever make these trades…

If you’re an experienced trader, have a high risk tolerance, and can get the timing exactly right, go ahead and make the bet.

What I am teaching here is that these patterns aren’t reliable, so even if the play works out once, don’t count on it happening again.

Unpredictability is the father of risk when it comes to trading. If the statistics aren’t good and you’re brand new or sort of new to trading, you’re better off trading something that’s been proven repeatedly.

Want to learn more about managing your risk?

Read my article here. 

What are reverse splits?

In a reverse stock split, a company reduces the number of its outstanding shares while increasing the share price proportionally. 

For example, in a 1-for-10 reverse split, if you owned 1,000 shares at $0.10 each, after the split, you’d own 100 shares at $1 each. The total value of your stock position remains the same, but the share price is higher, and the share count is lower.

Why do companies perform reverse splits?

Companies usually perform reverse splits to meet listing requirements of stock exchanges, avoid delisting, or attract institutional investors. Many major exchanges have minimum price requirements, and a reverse split can help a stock stay in compliance, especially penny stocks.

What you should consider when a company does a reverse stock split:

1. Signs of financial trouble

Reverse splits are often a red flag for a struggling company. Companies usually resort to this tactic to meet listing requirements or to avoid being delisted. Trading a stock undergoing a reverse split can mean you’re dealing with a company struggling to stay afloat.

2. Decreased liquidity

After a reverse split, the number of shares available for trading decreases. This reduction in share count can lead to lower trading volumes and decreased liquidity. 

With lower liquidity, it’s harder to buy or sell shares without impacting the stock price significantly. 

3. Increased volatility

The reduced number of shares means each share now carries more weight, causing significant price movements on relatively small trades. 

This volatility can be a double-edged sword. It might offer potential for quick gains but it also increases the risk of large losses. For most traders, this level of unpredictability is a risk not worth taking.

4. Dilution risk

Companies that perform reverse splits often follow up with dilutive actions like issuing new shares to raise capital. 

Dilution can further decrease the value of your existing shares and hurt traders that held onto their stock after the split. Basically, you’re left holding a smaller piece of a possibly shrinking pie.

5. Negative market perception

Reverse splits are generally viewed negatively on Wall Street. 

They’re seen as desperate moves by companies trying to artificially prop up their share prices. This negative sentiment can lead to further stock price declines as investors flee, intensifying losses.

Here are some recent examples of reverse splits that bit the dust on Day One:

Pagaya Technologies Ltd. (NASDAQ: PGY) instituted a 1 for 12 reverse split on March 8, 2024. PGY got the expected spike and then died.

And then there was Telesis Bio Inc. (NASDAQ: TBIO) that did a 1 for 18 reverse split on May 9th. It got a teeny tiny pop and then…nothing.

Just last week Nuwellis Inc. (NASDAQ: NUWE) initiated a 1 for 35 reverse split…

There are better alternatives for newer and more risk-averse traders.

Instead of risking your capital on reverse-split stocks, consider these alternatives:

1. Focus on quality stocks

Look for fundamentally strong companies with solid financials and growth prospects. Quality stocks offer better long-term potential with lower risk.

2. Learn technical analysis

Use technical analysis to identify entry and exit points in all stocks, including penny stocks. This approach can help you capitalize on market movements, even in troubled companies.

When it comes to trading platforms, StocksToTrade is first on my list. It’s a powerful platform that integrates with most major brokers. I helped to design it, which means it has all the technical indicators, news sources, and stock screening capabilities that traders like me look for in a platform.

Interested? Grab your 14-day StocksToTrade trial today — it’s only $7!

3. Diversify your portfolio

Don’t put all your eggs in one basket. Spread your investments across different sectors and asset classes to protect your portfolio from significant losses.

4. Stay educated

Continually educate yourself about market trends, trading strategies, and risk management. Knowledge is your best asset in trading. The more you know, the better prepared you’ll be to make informed decisions.

Subscribe to my Daily Income Trader service. It includes tons of training, daily webinars, preparation tips and everything else you need if you’re brand new or an experienced trader. 

5. Try other strategies besides day trading

If you don’t want to micromanage your day trades but also don’t want to wait months and sometimes years for the returns of a buy-and-hold strategy, maybe swing trading is right for you. 

Swing trading is the happy medium between day trading and long-term investing. Learn more about it here in my recent blog post.

And if swing trading interests you, you should check out IRIS, our proprietary AI-driven platform. It’s the optimal tool for swing traders. 

Subscribers to IRIS get live training sessions, stock watchlists, weekly analyst reports, and much more.

Watch this presentation to see if IRIS is right for you.

In the meantime, have a wonderful holiday! I’ll see you back here on Friday.

Tim Bohen

Lead Trainer, StocksToTrade