Risk / Reward Analysis on Micro & Low Cap Securities (Penny Stocks): How to Research & Trade Penny-Stocks
Risk / Reward Analysis on Micro & Low Cap Securities (Penny Stocks)
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3. Identifying and Predicting Catalysts
5. Identifying and Predicting Risk
6. Completing your Risk/Reward Analysis
7. Risk Reward Analysis Real Example
8. Risk Reward Outline
1. Overview: More and more often I find retail traders new to investing drawn to the highly volatile micro cap community. And who can blame them? A three cent increase on a micro-cap security trading at fifty cents per share will net the trader a 6% return. And who am I to judge? I've made thousands on the rare occasions I could find a penny stock with low relative risk and imminent catalysts. But that is the trick now isn't it? Low risk and promising future price action. By the end of this entry you will know how to assess risk and reward pursuant to conducting DD on micro-caps so you aren't blindsided by easily foreseen obstacles on your path to profitability.
Note: Due Diligence IS NOT looking at the easily found numbers, stats, and price targets combined with all the good news, patents, and life altering medical pipelines that make a security look attractive. While this information is important, particularly for identifying catalysts, in order to be proper DD you must not only look at the possible risks, but estimate risk probability and why. Only then can you estimate when those risks are most likely to come to fruition. In the penny stock world those risks are only a matter of time. Doing DD by looking at all the good isn't DD; Its confirmation bias. And confirmation bias leads to bad trades. You must do a risk assessment if you are to complete proper DD!
2. Catalysts: If you are looking at a penny stock you were likely lured in by a possible catalyst. Penny Stocks are perhaps the most sensitive securities in the market when it comes to both good and bad news. A catalyst is a figurative launching platform that can send a security higher and higher. Penny stocks with catalysts aren't hard to find. Day traders will regularly advertise them after the fact. It is important to note that their interest is not yours. A trader never wants to chase the price action after the catalyst. Penny stocks can dump quicker than they've pumped, and often do. You will find out more about this when you get into the risk section of this entry but for now it is important to realize that investing in a penny stock without a probable imminent catalyst is a good way to throw away your money. The question is therefore "how can I find the catalyst before it occurs?"
Note: The overwhelming majority of day traders LOSE MONEY by chasing securities they have no historical knowledge of. This is because they saw a trending security and jumped in WITHOUT assessing the risk. ... What? So you know some day traders who claim they aren't losing money? Have they showed you their annual portfolio balance?
3. Identifying Types of Catalysts: Catalysts include but are not limited to the following:
- 3a. Good Earnings: If a normal company outperforms revenue and earnings per share (EPS) expectations when they report earnings they are considered to have "beat earnings." However many microcaps, particularly pharmaceutical companies, have yet to realize profitability. In many cases they have yet to acquire a marketable product altogether. In these scenarios good earnings is often considered if they have enough money to last a while before making another offering again. That is easy enough to assess based on past offering history, although it isn't the only thing you should look at. You'll just need to look up the relevant 8-K's that pertained to offerings and assess based on past earnings (the most recent 10-K's or 10-Q's) if they have enough money to last a while. There are certainly other things that could come out during quarterly earnings that may bode poorly for the security. It is therefore also important to see the most recent public relations releases which can also be found in 8-K's.
- WARNING!!! Sometimes microcaps trade with some solid momentum before earnings; already pricing in the expected beat before dumping after. Sometime market makers short them hard immediately before earnings only to cover and accumulate before the probable pop.
- 3b. Expected Good Earnings: These are earnings where good news is expected which creates a pre-earnings pump. There are a number of scenarios in which traders have reason to expect good earnings on a security. The best way to find them is to look for recent spikes in security price where a public offering was suddenly implemented to raise money. Yes, the security price experienced a sharp decline but that spike in security price did not come out of the blue; there was a catalyst that shot the share price up beforehand which may be reported in more detail during earnings. Once you find the date of the spike look for the catalyst the drove it up in the media or adjoining public relations 8-K. If you do not want to play the earnings then fine … simply ride the security up until the day of, or the day before, and sell it before earnings are announced. Remember that earnings report dates are among the few times when you know exactly when a company is going to release information. The price will no doubt reflect this. A possible way of finding these pre-earnings plays are to check earnings calender's and go one by one searching for penny stock reporting dates. Look for ones with recent good news, recent catalysts, or perhaps an offering that destroyed the momentum of the share price. Remember to do your risk assessment!
- Note: There are many online earnings calendars. It is important to understand that many of them list when a company is EXPECTED to report earnings, not when they are ACTUALLY reporting earnings. In the absence of clarity ensure the expected earnings date matches the expected earnings date in other calendars. You can find a list of earnings calendars HERE.
- 3c. Profitability: If a microcap company is suddenly profitable, or more profitable than expected, there is a solid chance that it will realize an increase in security price. Increased year over year profitability is the number one indicator of a probable increase in security price. You will generally get this information from quarterly or annual earnings reports. Assessing profitability can be a tough task, dependent on the type of company, and is beyond the scope of my intent of publishing this tutorial; though there are plenty circumstantial indicators.
- 3d. Enough Funding to Make it into the Following FY: Penny stocks are penny stocks for a reason. Many microcap companies are operating off of borrowed money or, in some cases, heading toward bankruptcy. Pharmaceutical companies researching novel drugs are particularly in need of shareholder funding to make it to the next stage of development. Companies often update shareholders during quarterly and annual earnings reports on their funding and how long they expect that funding to last. Generally, all things being equal in these types of circumstances, if a company reports that they have enough funding for a year or more, the security price typically increases. In order to gauge if a company has enough money to make it to the following FY I recommend looking at their last Pre-14A or DEF-14A. Or perhaps their last 10-K or 10-Q. The most recent document will give you the best information. Through these SEC filings you can usually see their financial estimates and they generally tell you outright how long they can sustain operations on current funding levels. Once you have that information down you look at their offering and fundraising history and check out how often and how recent money was raised since the last time they reported their financials. You’ll also want to review 8-K’s to see if they’ve changed the nature of their operations which could make their cost of operations more expensive. If you assess they have made operations more expensive through further investment/expansion, or, operations will get more expensive as things progress (like they often do in pharmaceutical companies), you can assess that they will need money sooner than originally thought.
- ALWAYS REMEMBER! Just because they say they have enough funding into the following year DOES NOT mean they will wait until the following year to raise money! It simply means that an offering is not likely at the current time. A company operating on shareholder credit will need to raise money again! So the possibility is ALWAYS present! The question is therefore one of probability.
- 3e. New FDA Trial Filings: When a pharmaceutical company files for FDA approval to begin a new trial, FDA approval to advance a trial, or FDA approval to approve a drug, the security price of the adjoining company generally goes up. For microcap companies the security price skyrockets! It is always best to get in before they are expected to file. You can estimate this by paying close attention to their pipeline, their investor relations page, and SEC Form 8K filings. For additional information you may want to check the FDA calendar, look at clinical trials, or see what they have in Biopharm Catalyst. Don't forget their twitter feed and Facebook page as well. You may not get on right before they announce but you can get close enough to turn a solid profit. To find out when they will likely file its best to assess current operations and press releases. You can also find forums like StockTwits and Reddit and ask around BUT ALWAYS VERIFY THE INFORMATION! Be careful not to invest in microcaps where the news is already priced in. That may be determined by closely monitoring the price action before hand. You will know if the price is over-pumped. REMEMBER to do your risk assessment! Sometimes companies release offerings soon after announcing FDA filings.
- 3f. FDA Advancement: After a pharmaceutical company submits for advancement of their pipeline you will notice a sharp spike in the price of the security; typically followed by a sharp decrease finally resulting in a gapping up a few cents from where it was before. The reason for the increase is the rush of opportunistic penny flippers/chasers rushing in to profit off the momentum. Most will become bag-holders. The decrease is a result of the shorts coming in as the penny flippers are selling out. Microcap pharmaceutical companies regularly plan offerings around FDA pipeline advancement news (so do your risk assessment). Penny chasing is a horrible way to do business and you will inevitably lose money. To see how close a company is to further advancement you can look at all the aforementioned resources (Biopharm Catalyst, Clinical Trials, or FDA calendar) or seek additional resources here.
- 3g. FDA Approval: If the FDA approves a drug the share price of a pharmaceutical company generally skyrockets. I say “generally” because this is not always the case. I have seen decreases in share price due to the fact that approval was already priced in. Additionally, sometimes the next step for a pharmaceutical company is to market their drug which requires raising money. However generally the price increases. Once again you can find filing in the aforementioned sites above (Biopharm Catalyst, Clinical Trials, or FDA calendar) or seek additional resources here.
- Note: You should always ask yourself before you invest in a penny pharma if the drug they’re working on has enough demand in the marketplace to justify your risk. If, for example, someone is working on a drug to cure a very rare disease, or perhaps a cure for a common but necessarily untreated ailment, will the drug sell? Additionally, you should look for companies working on other, and perhaps, better drugs. I’ve seen pharmaceutical companies enjoy approval of their drug in one month only to see the share price plummet as another company gets a better quality, better functioning, and cheaper drug or device approved the next. This rendered the former company’s drug or device obsolete.
- 3h. FDA Fast Track Status Approval: Fast track designation ensures a drugs priority and rapid succession down the pharmaceutical pipeline. No it is not as fast as it seems but when the FDA awards fast track designation the security price does increase. Additionally this creates a scenario where catalysis come more often which mitigates long term bag holding. Fast track status is usually granted for drugs that are in immediate demand in the marketplace for illnesses that have few successful treatments.
- 3i. Patent Filing and Approval: When a patent is filed or approved it naturally increases the share price of a security in both circumstances. Patents can be filed in a number of countries but the gold standard is to have a patent approved in the United States. Patent rejection will naturally have the opposite effect. Here is the website to the U.S. Patent Office.
- 3j. Partnerships: Partnerships can be a wonderful endeavor for a company. Generally, a partnership means someone is coming in with their own money to help advance a product. For the shareholder this typically means less fundraising and share dilution. It can also mean that a big company is coming in to fund research, production, marketing, and distribution of a good or service. There are a number of pharmaceutical companies that have a staff of 10-20 people and must eventually find a partner to help fund, produce, market, and distribute a drug. In many cases no partner means no drug. The partner also generally pays for licensing rights; meaning they pay the company to produce, market, and distribute their intellectual property. A partner often means the share price increases, as someone sees value in the product and are willing to put their own money down for it. There are a number of indicators that a partnership may be imminent. For example, if a pharmaceutical company has developed a drug that has been approved by the FDA, or a drug that’s shown promising results in trials, a partner can be around the corner. Pharmaceutical companies will generally notify their investors if they’re looking for a partner. Sometimes open source leaks in the media can indicate a partner is imminent.
- 3k. A Buyout: Quite often a large company asks itself “Why the hell would I pay for rights to a company’s product when I can just buy them out and sell it myself?” The share price generally skyrockets to whatever price the company agrees to be bought out for. Moreover, if a company rejects a buyout because they consider the offer price is too low, shareholders will enjoy a boost in share price. However, if word is leaked that a buyout offer came in for less than what the share price was trading for, shareholders will see their equity plummet. If the buyout is hostile it is typically bad for shareholders. Generally to prevent an unwanted takeover the sought-after company begins diluting shares and exercising warrants to retain their majority stake. Buyout indicators are similar to searching for indications of a partner.
- 3l. Insider Buying: If the officers or board members of a company are suddenly buying their own shares in bulk it is a solid indicator that they expect the share price to increase. Particularly if they rarely purchase their own stock like many of the microcap pharmaceutical companies do. Is it illegal for a CEO to trade on insider information? Yes! But let’s face it, they know best when they are going to make offerings, issue warrants, or advocate for a reverse split, and in most cases they aren’t going to buy large quantities of their own stock if they think they’re going to lose money. Be careful not to buy simply because a solitary company officer wants more voting power before a shareholder meeting. To see insider buying reports you can look for your companies SEC Form 4’s or look for previous insider transactions HERE.
- 3m. A Sudden Change in Market Conditions that Increase Demand for the Company’s Services: Remember when COVID-19 hit and the news ran stories of people buying out Costco supplies, stocking up on Clorox, buying up toilet paper, or buying all the medical face masks? Shortly after word hit the street, the share price of COST, CLX, PG, & 3M began to skyrocket. For the microcap pharma community anyone who mentioned anything to do with some COVID-19 relationship to their drugs, tests, or devices saw increases in some cases up to 500+%! This is an example of market conditions changing the momentum of otherwise un-noteworthy microcap companies.
- 3n. New Contracts: A microcap company's share price generally skyrockets when they receive a contract from a government agency or a large company. Getting a head of the curb on this can be hard but you can certainly profit from the subsequent PR and earnings reports.
- 3o. Institutional Investment: Large funds and capital management firms are considered institutional investors. When they establish or increase their position in a company it is generally viewed as a net positive. However not all capital management firms have a solid reputation for investing in microcap securities. Some buy up shares for the purpose of lending them to shorts for a premium. Some regularly assess a security’s potential to have a significant upcoming catalyst, short the hell out of it on low volume, and then slowly buy up shares on the cheap with the intent of making money on the catalyst. To see what institutions are investing in your favored microcap I recommend searching for your ticker on the web and typing the word “fintel.” Then click the ownership tab and click institutional investors. The institutional investment history will appear before you.
- 3p. Activist Investment: Activist investing is when a wealthy person or firm suddenly decides to buy enough equity in a company to become a board member of said company for the purpose of looking after the shareholders and increasing the share price. There are a number of activist investors out there of different success rates and reputation. To figure out what activist investors are in your favorite microcap you can simply search for your company’s SEC Form 13D filings.
Note on Penny Stock Alert Services: There are a number of penny trading alert services out there that will recommend when to get in and when to get out, but all too often the subscriber is left in the dark as to what is really driving the security. These services are often a waste of money and have more losing recommendations than winners. These trading services spend a great deal of time pumping their recommendations for free after they have alerted their subscribers. You can find a number of them on Twitter and Stocktwits. While I do not recommend blindly listening to these paid pumpers, I do recommend looking at their free alerts on Twitter and Stocktwits. Subscribe to their tweets to see what they’re looking at. They can be a great reference to begin looking for stocks with promising catalysts.
4. Risk: If you are not assessing risk you are not doing due diligence. DD without the risk is nothing more than a form of blinded confirmation bias that WILL lead to losses. Those who participate in purchasing a microcap security without first assessing the risk aren't trading or investing; they're gambling. Jumping into a security without knowledge of the company's history or their current financial situation is one of the primary reason the majority of day-traders lose money. Any day-trader that tells you that the information below is not worth your time if you are in and out of a trade during the same day is not doing you any favors. You will find that if you at minimum assess the information below the night before you decide to purchase stock in a microcap company you will see much better overall profit than you've experienced previously. You will have also likely avoided many imminent pitfalls that you otherwise would have been subject to, had you not completed your risk assessment. Once again, if you are not assessing risk you are not doing DD!
Note on Where to Begin when Searching for Risk: The risk section of the 10-K & 10-Q is perhaps the most important for assessing the possible long term issues faced by the company. Granted, if you are trading in the pennies you aren't going to be hanging around for long. But these risks are good to know. Not all risks are created equal in the risk section of the 10-K & 10-Q. You must choose which ones are the most important to your analysis. The good news is they practically give you the scenarios that can harm the company; often in order of importance. Items covered in the risk section of the 10-K/Q may include but are not limited to the following: Competition/Competitors, Seasonality, International Relationships, Supply Chain Issues, Expansion Issues, Contractual Issues, Taxes, Foreign Exchange Rates, Challenges to Protecting Intellectual Property, Government Regulation, Product Liability Claims, Litigation, Fraud, and other risks. By assessing the risk factors you can make economic indicators that would result in aggravating critical vulnerabilities and develop a plan that could help you mitigate the effects of these vulnerabilities should they come to fruition. Conversely you can come up with a list of economic indicators that could result in reducing the vulnerabilities and adjust your analysis accordingly. Once again the point is to enable you to act smartly on information, rather than be surprised by it, pursuant to protecting your investment.
5. Finding and Predicting Risk: Penny stocks are among the riskiest securities on the market. Sure, you can win big. However you can also lose big! The following are a list of questions you should answer before buying in a penny stock lest you lose big:
- 4a. Offering Risk: How Long can they Operate until they Need to Raise Money?: They will generally tell you how long they expect current operations to last at current levels on their most recent 10-K’s, 10-Q’s, or DEF -14A’s (look for whichever is the most recent). Find the most recent one and look for how long they expect to operate at current funding levels. Then estimate when they will raise money again. This will prevent bag holding due to offerings. REMEMBER! Just because they expect to operate at current funding levels until Q-1 2021 DOES NOT MEAN they will wait until that date to raise money! As said before you can also estimate their current financial standing by reviewing their last 10k/10Q or DEF-14A and reviewing the offerings since that time. Should give you a good idea. Previous offerings can be reviewed in 8K’s.
- Other Considerations: If you've done your research and concluded that a company has enough funding for a year, and then the same company releases a new product or starts a new drug trial, you can bet an offering will be coming sooner rather than later.
- 4b. Are there Outstanding Warrants? Check out their warrant history to see how many they issued, at what strike price, and how many were exercised. The left over warrants are a risk. If they are exercised you will experience a dramatic drop in security value. You can usually look for previous warrants both sold and exercised by sorting through their 8K’s. Warrants are generally sold with public/private offerings and have an expiration date of 5 years or so. Researching this will help prevent you from bag-holding due to the exercise of warrants. For example, if a company sold warrants a year ago with a strike of $0.50, and suddenly a catalyst boosts the security price from $0.30 to $1.00, you can likely bet that a warrant will be exercised around the corner.
- Note: Quite often market makers will exercise a warrant and buy a new warrant at the same time if they believe a micro cap has promising catalysts. This results in temporarily lowering the price for them to buy up more shares. These specific kind of dips are usually temporary
- 4c. When MUST they be Back in NASDAQ Compliance? If out of compliance they face either delisting or a reverse split. No one will want to be around for either of those. You can find their drop dead compliance date on their DEF 14-A’s and sometimes in other forms. 8-K's usually announce delisting notices. If there is a shareholder meeting between now and the compliance date, there is usually a vote on the R/S. If that is the case you know you are at least safe until the shareholder meeting. If that is not the case you must attempt to estimate if they plan a R/S in the immediate future. This will help prevent you from bag-holding on a surprise R/S. Remember they need to be above $1.00 for 10 days to a month (depending on the circumstance) to regain compliance.
- Note on NASDAQ Compliance: On When a security dips below $1 for 30 consecutive days NASDAQ will issues a deficiency notice to the company. Any NASDAQ company receiving a deficiency notice has four business days to file an 8-K form with the SEC or to issue a press release to announce the notice. After receiving a deficiency notice, a company has 180 calendar days to return to compliance. A company warned about its shares' minimum bid price must achieve a closing price of $1 or more for 10 consecutive trading days during this period. If a company with a minimum market value of $1 million in shares held by non-affiliates satisfies the other listing requirements, it may receive a second "cure period" of 180 calendar days. To receive this, the company must notify Nasdaq of its intent to correct the deficiency. If a company fails to comply with the minimum requirements during the first grace period or any second grace period, Nasdaq will issue a delisting letter to the company. As with the deficiency notice, the company must notify the investing public of the delisting letter within four business days, by filing an 8-K with the SEC. The company then can appeal its delisting to the hearings panel. Your companies last SEC Form DEF 14A or Pre 14A will let you know when they must be back in compliance.
- 4d. Are Institutions Increasing or Decreasing their Investment?: This one is obvious. Simply type the ticker into google next to the words “institutional investors” or "fintel." If institutions are selling it usually means there's a lot of money coming out of that security. It may mean the institution no longer has faith in the company, although, it could just as easily be assumed that the institution has made enough of a profit to move on. Circumstances will dictate what you make of it, but if you did your DD properly, you will know.
- 4e. Are Insiders Buying or Selling? Are they doing anything?: Another obvious one. You can find total insider shares on the most recent DEF-14A. You need to ensure that the folks owning the company are buying more shares each year. If not there is likely a reason. You will also want to know how much of a stake insiders have in their own company. A CEO who owns but a few shares (relatively speaking) is likely holding out for better times. You can find insider buying simply by looking for their Form 4’s.
- 4f. Is my Stock Actively Being Shorted?: You’re going to want to know the short volume, the short interest, the naked short interest, and the shares available to short. You will also want to know if the security is on the REG-SHO Threshold List (indicator of naked short selling by means of failures to deliver). Shorting presents both opportunities and risks for longs and shorts are often creatures of habit. For example, if there is a widely expected catalyst coming up what short is going to want to hold over a weekend? You therefore may make the assessment that a short squeeze may be imminent. Perhaps longs will aggravate the shorts as well, hoping to hop in before a probable catalyst. In these cases where there is high short volume and an imminent catalyst expected the following week, the smart shorts cover before Friday.
- FYSA The Short Sell Circuit Breaker List: Many traders are unaware of the Short Sale Circuit Breaker List. SEC REG-SHO RULE 201 is best summarized as when a security drops more than 10% in a single day the “Alternative Uptick Rule is in Effect” for the rest of that day and the following day. That simply means that you cannot sell a security short below market value unless there is first an uptick in price for the rest of the day and the following day.
- Note on Shorting Penny Stocks: Many retail trading platforms do not allow shorting of microcap penny stocks. One of the reasons is because it increases the risk for themselves and their customers. They don’t want to lose money on folks who can’t pay for a margin call on a security that skyrocketed 200% in a few seconds. Yet another reason is that microcap penny stocks are few and hard to borrow. The primary culprit of shorting microcap penny stocks are large market makers and investment firms. Their sole goal is to scare retail traders out of their positions and buy shares on the cheap on a possible catalyst. They operate on a different level than you, have access to much more information than you, and often implement automated trading platforms that both protect their short positions and screw over retail investors/traders. They are also the primary culprits of naked short selling. While a standard retail broker can get caught easily by the SEC for profiting off of naked shorting, private market makers and investment firms are not subject to the same level of scrutiny as they are harder to investigate. Therefore, the SEC does little in the form of preventing the illegal practice of naked shorting and on the rare occasions they do, they just stick the institution with a fine to make them go away. In the interim there is no recourse for the retail investors that were robbed or the company that was harmed.
- 4g. When was their Last "Mixed Shelf" Extension?: Mixed shelf filings are renewed every three years and are nothing to be afraid of. It just gives them permission to make offerings and sell warrants at will up to a certain amount of shares. Nevertheless retail traders will initially mistake them as a public or private offering which will send the stock into a temporary dip. Play this one how you will. You can average down or buy the dip. Weaker securities with no immediate catalysts may not come back up. But for the most part they do. You can see their last mixed shelf extension on the SEC Form S-3.
- 4h. What is the Penny Flipping Day Trader Footprint?: These are day traders that buy massive amounts of shares on a low float, low volume security and sell for a cent or two higher only to buy a massive number of shares again and sell for a few cents higher … rinse and repeat. These fellas do a lot on low volume to keep a good security stagnant or even increase selling pressure. However, they will benefit you when a catalyst drives up the security price as they all flock to feed like rabid wolves and become future bag holders. They also eat short volume though they can create sell volume of their own as well; particularly at the end of the day. You need them on good days, hate them on stagnant days, and despise them on bad days. You will love them when the security pops and hate them when they sell shortly after. No need to worry. Most of them are losing money.
- 4i. How Much Liquidity/Volume?: If there are too few shares and low volume it will increase volatility in both selling and buying and make securities hard to sell or buy. Best to stay away. These are usually easy to spot. Their charts look like building blocks.
- 4j. Are Insider's Selling?: If insiders of a microcap are selling and they aren’t stepping down, run for the hills. They know something you don't. Assess each case individually. You can look for insider transactions HERE. Of course, if a major company officer steps down or retires you can bet that too will be reflected negatively in the share price.
- 4k. At Risk for Bankruptcy?: Please do yourself a favor. Never invest in a microcap security of a company that is only a microcap due to extreme insolvency issues. Recent examples include McDermott (MDR). The Wall Street Journal among other outlets were reporting rumors of bankruptcy derived from industry insiders well in advance of their eventual bankruptcy. Yet penny chasers ignored them still, opting instead to chase a catalyst of another loan to get them over the next few months. Penny flippers were cursing the WSJ as "propaganda" on internet forums. Finally, a trading freeze was implemented and bankruptcy was announced. When trading finally resumed the security dropped instantaneously from $0.55 to $0.07 with a quickness that I have never seen. Traders were bragging about getting out with a 50-75% loss which, at the time, was indeed something to brag about. As MDR was in debt more to lending institutions than there was shareholder equity in the company, the shareholders lost all but $0.07 where it trades last time I checked in the OTC pink sheets. I understand that all shareholder equity was to be liquidated. The lesson here is simple. There are plenty of microcap securities to invest in. If the catalyst you're looking for is another loan to stay afloat on an over-leveraged financially insolvent company, you're risking too much. Stay away from financially insolvent companies!!!
- 4l. Less than 3 Products/Profit Potential: When a company offers too few primary products it increases the risk. A drug company that is only developing one drug could be destroyed if the FDA rejects their applications. A technology innovator working on new software or hardware would seriously be hurt if someone came out with something better. When there are too few products offered by a company and something catastrophic happens to their product line, it could mean imminent death to shareholder equity. Penny stock shareholders value a company based on profits yet realized. If potential profitability disappears because a company's only product is now worthless, so too will stock value. I've seen penny stocks crushed over 90% in a matter of seconds in such circumstances.
- 4m. Other Risks: Other risk factors include but are not limited to viability/feasibility of business model (Is there a real product and a real market for the product), competency of management (Are the management meeting their deadlines and responsibilities).
6. Completing your Risk/Reward Analysis: Analysis is rarely correct. The point of analysis isn't to be correct. It's to be as correct as possible with the information given. Therefore when speaking in an analytical framework you want to give degrees of certainty. Phrases like "impossible, not possible, low probability," "moderate probability," "probable," "highly probable," and "certain" are all examples of degrees of certainty. Additional examples include "low risk," "moderate risk," and "high risk." Other forms include "unlikely," "likely, and "highly likely." There are a number of synonyms you can use, but the important thing is that you are honest and you base your assessment on the information, trends, and underlying conditions in the market. If you judge something to be a "low risk," explain why you judged it to be "low risk."
7. Risk Reward Analysis Example: The following is an example of some DD I completed on DFFN (Diffusion Pharmaceuticals). Note that after this was published the security price skyrocketed over 150%. A good call!
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Friday May 1st 2020
Bottom Line Up Front: Diffusion Pharmaceuticals (DFFN) will Likely Experience a Significant Uptrend in Share Price in the Next two months.
Below you will find a summary of the company behind stock ticker $DFFN. The research is my own. The opinions and analyses expressed are my own and may not properly reflect the underlying conditions of this company or security. You should do your own due diligence. I am not a financial advisor. I am an amateur investor.
On 01 APR 2020 DFFN announced they teamed up with UVA Heath and iTHRIV to combat Acute Respiratory Distress Syndrome (ARDS) associated with COVID-19 infection. They have begun talks with the FDA and “will issue public updates as warranted by this fast-moving situation.” After this announcement DFFN share price went from $0.30 per share to $0.75 per share before settling at $0.40 per share. https://fintel.io/doc/sec-dffn-8k-diffusion-pharmaceuticals-2020-april-01-18353
On 27 APR $DFFN announced their pre-IND submission to the U.S. Food and Drug Administration (FDA) of a planned clinical program using trans sodium crocetinate (TSC) in COVID-19 patients. Under federal regulations, the FDA has up to 60 days to hold an advisory meeting with the Company, but for COVID-19-related submissions, the FDA has announced its intention to significantly shorten this period under its Coronavirus Treatment Acceleration Program. Clinical trial start-up preparations are continuing as the Company awaits the FDA’s response. To aid in timely trial enrollment, Diffusion is conducting expedited discussions with institutions located in areas of severe COVID-19 incidence, both in the U.S. and in Eastern Europe, to determine their possible participation. As a result $DFFN share price went from $0.45 per share to $0.85 per share before settling and holding at $0.50 per share until 30 APR. https://fintel.io/doc/sec-dffn-8k-diffusion-pharmaceuticals-2020-april-29-18381
Before the end of May DFFN will likely announce the FDA’s response to their request to begin the trial. While most traders are thinking of the FDA response many neglect to think of the European response. Therefore there may be two catalysts here. Much like recent submissions for other drug companies for COVID-19 related cases, it is highly likely they will receive an answer within the month of May. It is also highly likely that they will be given a fast track status. As TSC has had no “negative safety findings” or “serious adverse events” in their glioblastoma trial, they should be able to move directly into phase 2 trials. If they receive the FDA’s blessing DFFN share price will likely gap up and settle in the $0.60’s. As DFFN does not have a partner to help finance most of the trials for TSC it should not settle much higher than $0.75 at the most. The good news is that the potential high profile visibility that this trial offers will likely bring to DFFN to the attention prospective big-pharma partners. https://investors.diffusionpharma.com/News/news-details/2020/Diffusion-Pharmaceuticals-Evaluating-TSC-Against-Acute-Respiratory-Distress-Syndrome-ARDS-in-COVID-19-Patients/default.aspx
-Announcement of submission to FDA
-More info during ER (Possible date listed below)
-Approval by FDA
-Fast Track Designation
-Grant Money or Financial Partner
-Submission to FDA for advancement
-Approval by FDA to advance
-Submission for FDA Approval
-Marketing and distribution
-A partner to market and distribute TSC
Shorts love $DFFN: With news pending the chance shorts will have a significant impact on share price is low to moderate.
Reverse Split: On 17JUN2020 shareholders will vote to give DFFN the authority to initiate a reverse split. DFFN has until 24AUG2020 to regain compliance (Share Price above $1.00). A reverse split will likely happen between 01JUL & 24AUG if the COVID/ARDS trials do not propel DFFN share price above $1.00 per share for at least 10 days. https://fintel.io/doc/sec-dffn-diffusion-pharmaceuticals-def-14a-proxy-statement-2020-april-29-18382
Public Offering: Their last offering was in December and they have enough money to get them to Q1 2021. However last quarters financial estimates did not include the ARDS trial. No doubt they will get grant money, particularly with their partners at UVA. However if they do not have a partner to finance them in their other 3 trials expect another offering at the next couple of catalysis (Low to moderate chance) before July or amid catalysts after July (Highly Likely). Good news is their last offering was priced $0.10-15 cents above market value. It is possible but unlikely they will dilute their shares again with the security trading at its current price.
FDA fails to Approve the ARDS Trial: Low Risk as there are no safety issues, they currently have three trials underway, and TSC is shown to work on Hypoxic Tumors in their Glioblastoma trial.
-Phase 3 Glioblastoma Trial: Underway and showing promising results.
-Phase 2 Stroke trial: training first responders (slowed due to COVID-19)
-Phase 2 Pancreatic Cancer Trial (interacting with the USFDA regarding design of a clinical development)
Observation: Will likely get bought out by big pharma before making it to marketing.
Revenue potential for TSC: (tens to hundreds of billions)
Patents: US & Europe (patent portfolio ranging through 2031 with possible extensions to 2036 In addition Orphan Designations in the brain cancers, add an additional 7 years of exclusivity there.)
GBM Clinical Trial Results
Buy under $0.51 if you’re going long. Set your alerts. Decide how much money you want to commit. Build small position. Average down slowly with an equal sized position each penny or half penny it drops until you have the amount of shares you want to invest (should take days or weeks, not hours but best get in before the news). Be prepared to average down beyond your base position if necessary, but sell the excess you used to average down with for a small profit on the pops and short squeezes. This will not only increase your average down capital, but also pay for part of your position and give you peace of mind. If you’re a short term in and out penny flipper you’re destined to hold bags. The goal is to average down to the lowest possible price while selling excess shares on the pops with a permanent base position that will explode on news.
Important Reminder: $DFFN will need a partner to help fund, complete, and market TSC. No partner likely means no drug. No partner also likely means more offerings. A financially backing partner is the single biggest catalyst this security will experience!
Analysts Price Targets: I’ve seen estimates from $1.50-$3.50 per share.
Basic Security Info:
Observation: Anyone shorting this security while the ARDS news is pending is crazy!
Last offering: https://investors.diffusionpharma.com/News/news-details/2019/CORRECTING-and-REPLACING--Diffusion-Pharmaceuticals-Inc-Announces-35-Million-Registered-Direct-Offering-Priced-At-the-Market/default.aspx
Commonly Asked Question: Why has the stock price dropped so far? Answer: Past reverse splits, offerings, and short attacks. All risks addressed above. Although I personally have paid for 100% of my DFFN position by averaging down and selling the excess on the pops. (See investment strategy above).
-Earnings Report 5 May to 15 May 2020 (Unconfirmed)
-Shareholder meeting on June 17, 2020 at 9:00 a.m., Eastern Time, by means of a live webcast
-Reverse Split likely JUL-AUG 2020 if not in compliance.
-Offerings are highly likely after July to help fund FY2021
My Criticisms and Questions of $DFFN:
-They’ve been partner hunting for years. Where is the partner? Where are they in finding a partner? Are they ever going to stop diluting shareholder equity? Diffusion Pharma has destroyed their own stock and the money of their investors to pay the bills on what looks like an incredibly slow and foot dragging endeavor. For much if not all of their staff this is a second endeavor in addition to their career. A kind of “other source of income.” I question their urgency to develop TSC and bring it to market. They have a lot less incentive than their shareholders do in my opinion.
-Stage two Stroke trial is delayed because they couldn’t train first responders in time before the COVID-19 outbreak. I believe it shouldn’t have taken this long to train first responders.
-Diffusion Pharma usually releases news about once a month. Twice on a good month. Much to the anger of their shareholders who would like more regular updates.
-The CEO is asking for a vote on a pay raise for him and his partners who own very little of their own stock. I believe their compensation should be tied to their performance on advancing their pipeline over the last year and advancement in their share price. This of course means an increase in pay should be certainly out of the question! At this time they live exclusively off of shareholders and from what I can tell their tenure at DFFN is a side job for many of them.
Worst Case Scenario:
Worst case scenario is that the owners and staff at DFFN care nothing about finding a partner and are just robbing the shareholders through offerings to advance their drug and pay themselves a secondary income on their side hustle. They will complete a number of reverse splits and offerings between now and FDA approval as the money they stand to lose on their own shares pale in comparison to the money they pay themselves through shareholder benevolence and the money they stand to make when they advance this drug down the road. (No evidence of this but looking at the possible worst case scenario.
Best Case Scenario:
Diffusion Pharmaceuticals announces a partner within the next three months. They also announce in the next two weeks that they have attained FDA approval to begin their ARDS trial. The FDA grants fast track status to the ARDS trial. Diffusion Pharmaceuticals also announces that they are back on track for the stroke trial and have fully completed training of first responders 3-6 months from now. DFFN comforts their shareholders by telling them they have plenty of money as a result of their new partnership and will not do another offering in the next one to two years.
I am long $DFFN with a small 12500 shares at an average of $0.45 and will slowly add more in the coming week or two.
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This trade was both highly successful and wrong. But once again, no analyst gets everything correct. For example, I did not foresee the security exploding up to $1.40 in just two weeks. Also I forgot to search for the warrants, and sure enough, a warrant was exercised dropping the security from $0.62 cents to $0.47 cents before eventually exploding up to $1.40 on May 15th 2020. This is but one example of how you can incorporate risk and reward analysis into your DD.
8. Risk Reward Outline: You may consider the following in your analysis:
- Bottom Line Up Front (BLUF): Sometimes described as a (WIIFM "Whats in it for Me) this is what you expect to happen based on the following analysis. This should be completed last.
- Background Information: Include the most recent background information and price action as a result if it has bearing on future price action or the lack thereof.
- Analysis: What you expect to happen based on your combined knowledge of all factors involved.
- Possible Catalyst: What may drive the increase in price action in the future?
- Possible Acquisition/Buyout/Merger Target? Are they looking for a Partner?: Self Explanatory
- Possible Risks: What may drive the decrease in price action in the future?
- Assets, Trials, Pipelines: What do they have or what are they working on?
- Trial/Research Results: Are their trial results? How did they preform?
- Profit Potential: What is their potential for profit upon marketing?
- Patents: Are their any patents? Patents pending? In what Countries?
- Investment Strategy: How are you going to approach this investment?
- Resistance Levels and Support: What are the levels or resistance or support?
- Analyst Price Targets: Taken with a grain of salt. Most analyst price targets on penny stocks are useless.
- Institutional Ownership: Are institutions buying or selling? Who are they? What do you know about them?
- Insider Trades: Are insiders buying? Selling?
- Short Volume/Short Interest/Naked Short Volume/Short Shares Available: What is the short situation?
- Important Dates: What's coming up for the company? Include events that you know are coming but do not know the date. Estimate the date if feasible.
- Last Mixed Shelf Extension: When did they last file for a mixed shelf or mixed shelf extension? Hint: NLT three years from the last one.
- Criticisms and Questions: What are your criticisms and questions? Only those who know the company really well can answer this. What are your critical questions, information gaps, and questions of the company? Why or why not trust the leadership? Does the leadership have a significant stake in the company? Do they keep the shareholders informed and how often? Do they regularly release PR and how often? Are they progressing quickly or dragging their feet? Are they asking for an executive pay increase? Do they deserve a pay increase? Do the executives that work there do this as their primary job? Is this a secondary income for them?
- Information Gaps: You've covered your known known's, now cover your known unknown's.
- Public Relations Footprint: How often do they release PR?
- Worst Case Scenario: If the worst happens what will it look like? What will be the early indicators? Include time frames.
- Best Case Scenario: If the best happens what will it look like? What are the early indicators? Include time frames.
- Most Likely Scenario: What's most likely to happen? Include time frames.
- Other Analysis: What are your other observations?
Conclusion: There is no one way to conduct risk/reward analysis. Unless you do, however, you cannot honestly claim that you are doing DD on a security. Following this model, or at least incorporating it into your DD, can go a long way to ensuring that you mitigate risk and maximize profit. It will reduce surprises and place you in a position to act if the trade turns against you.
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