Heed High-Volume Plunges as a Warning

The size of a company’s trading volume matters, not the size of its market cap! As most Profit Confidential readers already know, for the most part, Lombardi Financial favors small-caps over large- caps.

Why? Well, when it comes to small-caps, it’s all about having room for growth. However, the growth potential of many small- caps is a topic that is discussed on many occasions. What I want to talk about today is the relevance of small-caps’ trading volumes, particularly when an investor’s investment horizon is short.

The small- and micro-cap stocks that we here at Lombardi Financial usually recommend are generally thinly traded. This is why any large order can cause a stock to spike or dip, depending on which way the order is entered. As a general rule, small-cap investors should sell into the rising market, usually within three to four days after the initial purchase has been made.

However, before you unload your stock, check whether its price surge is more permanent in nature or if it’s a temporary fluke. If a company’s fundamentals are driving its stock price up, for example, where a company gains FDA approval for a new drug or securing a potentially rich mining property, know that such corporate events tend to keep the price up for longer periods of time.

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Selling into a rising market due to a positive corporate event may be premature because of the stock’s long-term potential. However, if a large buy order is coming into the market — you can check for this by watching for volume spikes during a trading session — then the spike in the stock’s price is probably only temporary, in which case it may present a profit-taking opportunity for you.

When monitoring subsequent trading patterns, you may be even better equipped to determine whether a stock surge or plunge is temporary, or if it should be interpreted as a warning. For example, if a stock’s price rises on large volume today, but its increase’s tempo and trading volume are significantly lower tomorrow, then chances are that the stock’s price is losing steam.

By the same token, if the stock dips on thin volume, all it may take to see it spike again is the presence of a few bargain hunters. However, if the stock’s price decreases on large volume, then this may be interpreted as a warning sign of future developments occurring. High-volume plunges tend to last while low-volume dips usually don’t. So, watch for the high-volume plunges and treat them as warnings. You may also want to consider low-volume drops as a sign that it’s time to buy a temporarily discounted stock.