I want to talk to you about the “pendulum theory”. The pendulum theory is an old theory that we developed on Wall Street when a group of market makers would meet after hours for a snack without solid food. (Liver damage was an occupational hazard for market makers, as these academic discussions began about half an hour after the market closed and generally lasted until the bar closed.)

The pendulum theory says that the more the stock swings one way, the more it will swing the other. If the stock goes too high, it will go too low.

On the other hand, there are plenty of quiet stocks that don’t swing much, but they’re mostly not penny stocks. If these quiet stocks don’t swing much in one direction, they won’t swing much in the other direction.

The underlying viability of this theory is that stocks have certain financial and structural factors that determine the way they move.

Small companies are generally more volatile than large ones because less buying or less news will move the stock more.

If there is a relatively small number of shares in public hands, i.e. a small amount of “float”, the stock will tend to swing more violently since the amount of supply that can delay any buying coming into the stock is smaller. (Note that the float may change over time due to additions of people selling shares under Rule 144 or other sources.)

If the company is making a profit and its value is largely determined on those profits and a small profit margin, any expansion in the profit margin will produce a relatively large change in profit and therefore in price. For example, one company has a profit margin of 1% and another has a profit margin of 10%. If both increase their profit margins by 1%, the first company has doubled its profits but the second company only has a 10% increase.

In the case of penny stocks, their price is often determined by the effort and care that goes into informing the investing public. The old saying “stocks are not bought, they are sold” applies. I mean, not a lot of people are looking at small companies to buy stock. Rather, companies have to work hard to get people to buy their shares.

Another determining factor in the volatility of stocks is the presence of possible news. If the company, like many of the companies we look at here, is waiting for a deal, a lot of news makes the stock move quickly.

Finally, an attack by predatory short sellers can increase volatility.

Another aspect of the pendulum theory is momentum. Momentum simply means that penny stocks in general, and reverse merger stocks in particular, when in motion tend to stay in motion. They’re one-way streets for a while, until the pendulum swings.

With a volatile stock, the pendulum swings “too much” up, then too much in, then too high. So a stock can start to become less and less volatile as time goes on. Therefore, there may be less and less momentum in stock movements.

This is typical of some of these stocks, momentum makes them go too far and they are very volatile and treacherous to trade. But it makes it more fun and sometimes more profitable. Travel at your own risk! As always, we tell you this is a risky investment, don’t use more money than you can afford to lose and do your own homework. Include in your analysis some insight into float and other factors that will affect the volatility of the stock. You can find more facts in my books, How to Find a Home Run Stock and How to Pick Hot Reverse Meltdown Penny Stocks.