Lessons From A Penny Pro

The Phenomenon of the Reverse Stock Split

Companies often do this when their stock price is really high, making it less likely for the general public to buy and invest… by lowering the price, they could get more interest and higher liquidity in the stock.

On the flip side of the stock split… is the reverse stock split. Most people don’t actually know about this one, and with good reason… if you mainly trade blue-chip stocks, then you won’t run into this often… hopefully ever, if you own the stock…

So what is it? And why would you care about something most people don’t know anything about?

… because they create incredible trading opportunities and I am going to show you how you can potentially profit off the next one.

The Bad, The Ugly… and some Good

As implied by the heading, reverse splits aren’t something you want to see in a stock that you own… they tend to be a bad sign… but for traders, there is a little bit of good hidden in there… and we will get to that…

So what is a reverse stock split?

In reverse fashion from a Stock Split, hence the name… with a reverse stock split, instead of owning more shares at a lower price… you end up owning fewer shares at a higher price each…

So if you have 100 shares of a company trading at $1 and they have a 1 for 10 reverse split, you now would have 10 shares priced at $10… 1 share for every 10 you owned… and at 10x the price.

Reverse stock splits do not impact a corporation’s actual value or market cap… it’s simply a smoke and mirrors game…

Why Companies Go for Reverse Stock Splits?

Therein lies the Bad… hidden within good intentions…

One reason companies orchestrate reverse splits is to increase their share price to avoid being delisted from an exchange.

If a stock price falls below $1, the stock is at risk of being delisted from stock exchanges that have minimum share price rules.

Reverse stock splits increase share prices in an attempt to avoid delisting.

The company cares about this because being listed on a major exchange is important for attracting equity investors.

So while the intention is good, the result is not, which you will see in the chart examples below.

Another reason is to increase their share price, simply to avoid the “low-quality” stigma that is associated with penny stocks.

Now as you know, I love penny stocks… I have made a career worth millions of dollars trading pennies

So why would a company want to steer clear of that stigma?

Well, it’s simple… penny stocks are considered to be a risky investment. Now, this is partly true…

Using the term investment, absolutely… these stocks are trading under a dollar for a reason.

Would I invest in penny stocks?  Not likely…

But when we talk about trading penny stocks… hell yeah… they are ripe with some of the greatest returns I have ever found.

So again the company does this with good intentions… however, the result isn’t exactly good.

So why is the result not Good?

Generally, a reverse stock split is not perceived positively by market participants.

It indicates that the stock price has gone to the bottom and company management is attempting to inflate the prices artificially without any real business proposition.

Additionally, liquidity may also take a hit with the number of shares getting reduced in the open market which is not a positive sign for any listed company.

Okay, so that’s the Bad… let’s look at some charts and see the Ugly.

Below is a chart of FuelCell Energy (FCEL). What you are seeing it the effect of the 1 for 12 reverse stock split on May 8, 2019.

So if you had 12 shares, at about 20 cents each, before the reverse split… after the split, you now had 1 share for just over $2 each…

… same overall value… you just own fewer shares at a higher price…

Now the Ugly… look at what happened next… within 2 short months, the price tanked to the same level it was at before the split…

So you now have 1 share worth 20 cents instead of 12… great deal, right?

Imagine if you had a real investment in FCEL, nearly all of the value is gone just 2 months after the reverse split. And this is a very common result of reverse stock splits.

As mentioned earlier, the stock is trading below a dollar for a reason, artificially increasing the price, while the intention may be good, doesn’t change the underlying fundamentals of the company.

If you look back a little further, FCEL did the same thing… a 1 for 12 reverse split trying to keep the stock from being delisted from the Nasdaq. It didn’t take but a year and a half for the stock to be trading back down to the $1 level again…

The loss of value is unreal… well actually all too real… and that my friend is the Ugly.

And as promised… some Good…

For the trader, there is some good hiding in a reverse stock split…

Look at those charts again.

The large change in share price sets up some opportunity for volatility, just what we want to see.

You can see a consolidation in the middle of the chart just after the reverse split on the way back down… once it consolidates a short play is ready to roll.

And when the stock retests the original price, a great psychological level to watch, you get a little pause before a big bounce… giving you a great opportunity to pounce on the quick pop.

From an investment standpoint, I don’t want to be in a stock that needs to use a reverse split, let alone actually does one…

But from a trading standpoint, I can find opportunities to exploit.

And reverse splits are easy to find just by searching for a list, so you know there will be some action in them… the key in any type of trading is studying and learning the patterns and tendencies before jumping in.

If you haven’t seen the interview where I talk about my strategies for pulling consistently large gains from penny stock trading… check it out below… it’s very easy to follow.

 

Watch Here

 

Want to Be a Better Trader? Get Powerful Trading Strategies, Tips & Video Lessons… 100% FREE!