Picking Low-Priced Stocks Using Volume

08/12/2010 2:20 pm EST


Thomas Aspray

, Professional Trader & Analyst

One of few positives from the great bear market is that there are now many stocks from established companies that are still trading below $10, even one year after the March lows. Some of these companies have been in business for many years, and therefore, have a well-established price history. Many find low-priced stocks attractive for trading or investing because it’s easier for a low-priced stock to double or triple. Also, one can build a portfolio of ten to 20 stocks in different industries with a relatively small amount of capital. The primary tool that I use to find and select stocks to trade is to first look for stocks with unusual volume activity, but that is just the first step.
There are a number of sites like StockCharts.com, Finviz.com, etc. that put together lists of stocks that show abnormal volume for the previous day. These lists are often a good starting point. Then I look for stocks where the volume is at least two to three times the average volume listed on Yahoo! Finance or some other site, or alternatively, well above a 20-day moving average of the volume. The actual volume of trading is also important as under 50,000 shares per day makes trading anything over a few hundred shares more difficult. Also, it is critical to use limit orders in these stocks for both the entries and exits, as otherwise, the sometimes wide spread between the bid and ask makes market orders very unfavorable. Let’s look at some examples.

Figure 1

Click to Enlarge

This chart of Oncolytics (ONCY) is from 2007, just before the overall market peaked in October. On the bottom of the chart, I just have the volume plotted with a 20-period MA of the volume. The stock had spiked to $2.47 in early June on volume of over 240,000 shares, but by September, it had declined back to $1.45. There were two days in the middle of the month where the volume was well above average (points 1 and 2), and on both days, ONCY closed near the day’s highs. The rally that began on September 10 (point 1) lasted just four days, and on September 18 (point 2) ONCY’s low was $1.44 as compared to $1.45. These lows were retested again late in the month, allowing one to easily define a stop level for new positions. Also, the low volume on the pullback did suggest accumulation. On September 28, ONCY skyrocketed on four times the average volume and closed at $1.89. Volume doubled the next day, but the close was well below the highs.

There are several points I am trying to make here. Firstly, a sharp increase in volume alone does not set up the trade; you also need a tradable chart pattern and a well-defined stop level. Additionally, in my experience, the first volume surge often sets up a good trading opportunity a week or even a month later. In this example, ONCY corrected for several days before staging a major upside reversal (point 4) as the 78.6% retracement support held. More often than not, the 61.8% support will hold on a pullback after a large volume surge. The next day’s open was at $1.88, and the following day, the low was $1.82 before it closed the day at $2.07. A stop on new longs under the reversal day’s low at $1.65 (such as $1.62 or $1.59) would have been reasonable. The 100% Fibonacci projection target using the first sharp rally and projecting from $1.65 was at $2.50, with the 127.2% extension target at $2.45. This was a good first target area, and it was hit within a week before ONCY eventually hit $2.77 (the 161.8% extension target) by early November.

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Figure 2

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Fast forward to late 2008 and early 2009 as volume on February 10, 2009 was eight times greater than the average and ONCY surged well above its short-term downtrend (line a). By mid March, the converging support in the $1.15 area (lines a and b) was again being tested. For nine days, the ranges were tight, and in light of the prior surge, buyers could have used a stop under $1.15 or even below the December lows at $1.03. An even better trading opportunity occurred just two weeks later as after a brief but good volume rally (point 2), ONCY pulled back to the $1.21-$1.27 area (circle 3) on low volume. The move through the new downtrend (line c) on building volume supported the bullish case. The Fibonacci extension targets at $1.74 and $1.90 allowed one to assess the potential risk/reward on new long positions. Several days before the highs at $1.95 (point 4), there was another high volume surge. I included these two examples using ONCY to illustrate how often a low-priced stock will give you multiple opportunities to trade over several years.

Figure 3

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CEL-SCI Corp. (CVM) is a very low-priced, but liquid stock, and one that I have traded in the past. On June 5, 2009 (point 1), CVM gapped above the resistance at $0.44 on 32 million shares, 20 times above the 1.5-million-share average. For the next two and a half months, CVM consolidated and held the support in the $0.37 area. In the latter part of July (point 2), there was another high-volume spike, though CVM once again pulled back to support. This allowed one to draw a resistance level at line a, which was surpassed on August 26 (point 4). The volume on this day was heavy (point 3) and equaled that of June. The pullback in early September held above the short-term 50% support level as volume was below average for about five trading days before again increasing to 12 million shares on September 10 as CVM closed above the previous high. Within just a few days, volume surged to over 67 million shares, and by September 22, CVM was over $2.

Figure 4

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My favorite volume indicator, the on-balance volume, or OBV, can also be very useful in identifying accumulation as well as distribution. This is a very recent example from just the past few weeks: Biodel (BIOD) surged up to $6.25 in early May on heavy volume, but then began a well-defined downtrend. On July 20, it formed a doji with a low of $3.25 just above the February lows at $3.22. The OBV moved above its WMA three days after the lows (point 1), and the ensuing rally took BIOD up to test the daily downtrend (line a). Volume picked up nicely (point 2) just before the downtrend was tested, and the pullback to $3.73 (point 3) held above the short-term 50% support level. Again, it was positive that the volume was low on the pullback. A stop on new longs under the 78.6% support at $3.46 could have managed the risk. As for targets, a rally equal to the first rally phase (100%) would take BIOD to $4.75 with the 161.8% level at $5.21. Both were hit in the next three days.

Having your sell orders in place is recommended because these stocks can turn around quickly: BIOD has recently dropped back to the $4.00 area after making a high of $5.27. The key 78.6% support level is at $3.68, and if we get a pullback to this area, the volume should be watched closely.

So let’s summarize. Often times, a stock will see several significant volume surges before a major move occurs. These initial moves can also be traded, but you need to take profits when you get them. When several volume surges do occur, look for a significant technical pattern, such as a retest of a breakout or a good base of support, as this will support your volume analysis. I usually try to take at least half off at the first target, and unless the rally starts from a significant base formation, I take the profits on the other half once a second target is reached or if I see a loss of upside momentum. Be sure to use limit orders for both entries and exits, but of course, you still may have some slippage on stop orders.

I wish you good trading!

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