The silent killer in the background: Warrants. (Post 22/45)
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Welcome to post #22.
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Last post, we discussed SEC filings — the do's and don't's, including spotting an 8-K catalyst and avoiding S-3 dilution traps before clicking the BUY button.
But with this now, let's discuss something more stealthy. The silent assassin that is responsible for the majority of the large cap stock runs.
Warrants.
Not all of these will be shown on a standard chart. The penny stock may be a clean stock, with very low float and a large volume. It appears all is set for an explosive squeeze. You buy in at $1.20 and anticipate that it will go straight through $2.00.
Rather, the price spikes to $1.50 and plummets into a wall that is imperceptible.
Millions of shares change hands, the tape rolls quickly and the stock just can't get any higher. What gives?
Warrants are now in the chat.
The dirty truth about penny companies making money. Large venture funds or institutional lenders don't lend money to anybody out of the kindness of their hearts when they are in need of cash. They require a sweet deal known as warrants.
These early investors have the legal option to buy new stock from the company at a set, reduced price through a warrant. Say, $1.00.
Now, suppose that the price of a stock goes from 40 cents to $1.80 on a lot of retail hype. What is the job of the warrant holder?
At $1.00 they exercise those warrants, and they get millions of new shares and they sell them all in retail buy orders at $1.75.
It is not money that has to be risked or money for free for them. And it wipes out your trade altogether.
You believe you're trading against other retail traders, but you're actually buying in almost all the new shares that are being printed. Hence, a penny stock can trade 50 million shares in one session, appear to be on the verge of bursting and then bleed all the pennies back down to where it began.
When you're trawling through those SEC filings we talked about, look out for any private placements or debt offerings lately. Check outstanding warrants for the exercise price. If the strike is at or just above, it's a walk in the park.
Don't accept an invisible ceiling. Respect the warrants.
Let's meet next post as such.
There’s a quick summary of the above above: In this post, we examined how warrants can be a silent killer in penny stocks. We covered how cheap shares are sold to retail investors during big rallies to smash any momentum, and how a “ceiling” is created that can never be seen by those making the big move.