Blog : Capitulation in Penny Stocks

by Peter Leeds on July 31st, 2012

When it comes to penny stocks, 'capitulation' is a wonderful word.

When everyone who wants out of a stock is selling, or has recently sold, you are facing capitulation.  This is true of large stocks, and it's just as true for penny stocks.

This generally results in shares dumping lower, free of any connection to the underlying fundamentals or business prospects of the stock. Perhaps that sounds familiar to what we've been seeing in penny stocks lately.

At the end of the capitulation, the shares have fallen so much that even the most disenfranchised investors won't unload their stock for the paltry prices they would get for it. In other words, a total and true price bottom.

Then a beautiful thing happens. The prices start rebounding. Capitulation has created the perfect investing scenario where:

- all the negatives have been factored into the share price

- group selling has driven stock prices well below realistic value

- buyers pay less for what the stock crowd no longer wants

We are seeing a lot of capitulation, and weakness, among penny stocks lately. Expect things to be very different in the coming months, than what we saw over the last several.  Some of the valuations we are seeing in penny stocks lately make absolutely no sense.  The prices of some penny stocks are even below their cash break-up value!

We do not expect this situation to last in stocks or penny stocks indefinitely, and we believe that cooler heads and more realistic stock market valuations will prevail.

Remember, there are 2 kinds of risk in stocks (and penny stocks).  Market risk and company risk.

Market risk is when the entire stock market, or market segment, trades lower together. This should not cause too much concern about the underlying stocks, because it is more of a technical, trading in sympathy type of event move. (All boats sink with the tide).

Company risk is when a specific stock drops off in price, even when the rest of the market, or it's sector is not. That is usually a warning sign for your stock.

Luckily, with current penny stock capitulation, the weakness is across the board. In fact, shares of penny stocks have been under pressure in just about every industry group, and at various price points.

The reason I say, 'luckily', is that this broad-based capitulation is related to market risk. We should see penny stocks, in general, perform well in the coming months.

In other words, don't fret. Penny stocks having tough times should recover, given a little patience. Recover, and possibly perform strongly from here on out.