Trading

How to Trade Volatile Small-Cap and Penny Stocks: Day Trader

Goverdhan Gajjala began trading stocks using a swing trade strategy, requiring him to hold positions for longer periods.

It was an approach that entailed deep research into market conditions, company fundamentals, and technical analysis. He had taken an online trading course by Mark Minervini, a veteran stock trader who had won the US Investing Championship, and spent a year learning the content.

But even with all the preparation that went into a trade, there were still uncontrollable factors that could impact price swings, and those risks increased the longer a stock was held.

After a few years of attempting to swing trade, Gajjala searched for an approach where he could feel more in control of his trades. By 2021, he had begun to take up an interest in day trading after observing recognizable patterns of stocks that would see volatile price swings within a day. They were often small-cap or penny stocks but could sometimes be larger caps.

Gajjala began making quick trades using small amounts of $20 as he practiced his skills. In the meantime, he continued his day job of being a software consultant. His early experience consisted of seeing some gains only to lose them again. He was grappling with impulsive decision-making and emotional reactions that were caused by a fear of missing out and revenge trading, which is trying to reclaim losses by taking aggressive trades.

His bad habits stuck with him until 2023, when he decided to test his trading skills by entering the investing championship. At the time, he still hadn’t mastered the ability to remain consistently profitable, but he wanted to follow in Minervini’s footsteps and get the feel of competing. His desire to win the championship pushed him to tighten his strategy and work on his emotional reactions. By April, his luck began to turn and he gradually increased his gains while limiting his losses. In the event he took a big loss, he would reflect on the mistakes and renew his determination to stick to a process that curtailed his emotional reactions.

He ended up finishing the competition in first place with an 805% gain, according to monthly brokerage statements viewed by Insider and results vetted by the championship founder, Norman Zadeh.

Zadeh previously told Business Insider that Gajjala’s strategy requires making a lot of trades, which means his record is highly statistically significant. He added that Gajjala’s win ratio was about 30%, meaning that his gains needed to remain consistently larger than what he bet and his losses needed to remain small.

Additionally, Gajjala’s high-volume trading required constant scrutiny of the market, something that not many people can do, Zadeh said. Most traders who attempt to generate such returns lose.

The strategy

He crafted his trading strategy down to using five-minute charts and holding positions for short periods. He trades about five different chart patterns and only uses technical analysis. His main strategy is focused on stocks with high demand, signaled by trading volume that increases with a stock’s price and also gradually reduces when the price does. It’s a setup that suggests buyers will step right back in to reinforce the uptrend when it resumes. In a previous interview with Business Insider, he broke down his core strategy.

But for volatile stocks that move more quickly than gradually, a pattern he uses to determine when to enter a trade is the bull flag pullback. This is when a stock quickly rises, followed by a slight pullback that’s likely caused by traders scalping profits, before it takes off. The demand for the stock is so strong it creates momentum that spikes the price. In short, it creates a pattern that looks similar to a flag on the chart.

It’s a faster-paced trade that requires a minimum of two-bar spikes in volume parallel to two price increases. It can sometimes extend into three or four candles, he noted. For this trade, Gajjala has less time for analysis and needs to execute within the first and second bull flags. His entry point is the first high after the pullback or the first green candle.

The red circle in the chart below demonstrates what a bull flag pullback looks like on a chart. The gray arrows indicate where Gajjala generally enters a trade.

This chart demonstrates stock price volatility and day trader's entry and exit points.

Bull flag pullback chart pattern.

Thinkorswim



He plays the first and second bull flag pullback but usually avoids the third one as momentum could begin to drop, increasing his risk that the trade will turn against him.

He sets his stop loss either at the lowest price of the most recent pullback or the last candle in the flag part of the pattern. It marks the lowest sell-off price. Therefore, if the thesis is correct, the price will spike higher; if not, the price will drop below the stop loss, and he will need to exit the trade.

To find the day’s movers, he looks at the default scanner in his brokerage account to filter stocks that move above 25% in premarket hours. He also uses a second scanner for trading hours that are filtered based on small caps, with prices per share between $0.50 to $100, with volume above 1,000,000 to ensure the stock is liquid enough to trade, and with a 25% increase for the day. The second filter generally lists about five to eight stocks for the day. He then watches those charts to see which ones form patterns he recognizes.

For example, on December 22, at 8:45 a.m. Nextplay Technologies Inc (NXTP) showed up on his premarket scanner after it spiked by about 200%, going from $0.95 to $2.85. Once the market opened, it showed up on his second scanner. Gajjala continued to watch it. By 9:45 a.m., the stock spiked from $1.64 to $2.39 within three candles or 15 minutes, creating the pole. He then observed the pullback, which took place in three candles with a price range between $2.01 to $2.30. According to records of his brokerage account, he entered the trade at $2.40 for 5,000 shares for $12,000. This price entry was near the previous high before the pullback. His stop loss was set at $2.01, which was the lowest price point of the pullback; it marked the second candle. He scaled out of the trade between $2.47 to $2.49 at about 11:40 a.m. during a pullback. However, Gajjala had expected the trade to rally higher, but it didn’t.

The chart below shows Gajjala’s NXTP trade with the green tabs indicating his entry point and the red his exit points.

A chart demonstrating day trader's entry and exit point for stock price volatility pattern call the bull flag pullback.

Day trader’s entry and exit points with number of shares.

Thinkorswim



But trading bull flag patterns doesn’t always go exactly as Gajjala expects.

On September 28, Bionomics Ltd (BNOX) spiked during pre-market hours, showing up on his scanner. Gajjala kept it on his watch list for a few days. By October 3, the stock began to rally in price again, going from $3.86 to $4.34 at about 10:35 a.m., forming the first bull flag. He had not been watching the stock. By the time he did notice it, it had begun to form the second bull flag pattern. He decided to take the trade due to a fear of missing out.

However, he entered too late and with a large position size, buying 20,000 shares at an average of $5.18 for a total cost of about $103,700, according to his brokerage statement. He had also not set a stop loss, assuming he could exit manually. However, the stock price dropped too fast, and by the time he was able to exit, the price was at an average of about $4.78. The incident made him realize that instead of trying to force a trade he already missed, it would have been better to stand back and wait for another setup.

The chart below shows Gajjala’s BNOX trade with the green tabs indicating his entry points and the red tabs his exit points.

A chart demonstrating day trader's entry and exit points on volatile stock.

Day trader’s entry and exit points.

Thinkorswim



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