Why I Pay Attention To Stock Splits

June seems to have found the market back in rally mode, which gives me hope that there’s going to be increased potential for momentum in the coming weeks. That’s something that I and many of the Warrior Trading traders have been hoping for after months of indecisive and choppy markets.

Unfortunately, I put the cart before the horse hoping that the market’s consecutive up-days would mean our scanner would find stocks with strong moving averages with a bit more follow through. In the end I took a big hit the first day of June.

The last week has been proof enough that the market and I have not yet come to an understanding. Momentum has unfortunately not been a consistent answer to trading the open. What has proved more profitable in recent trades on Jaguar Health Inc JAGX is the strategy of trading stocks coming off of reverse splits.

Briefly, For those who don’t know, a stock split is a way for a company to alter the value of its shares by either dividing each one into multiple shares that together equal the pre-split value of the share, or combining two or more existing shares into one. The end result is that the company’s overall market cap is the same, and investors have the same value of equity, but each individual share is worth less or more depending on the type of split. Stocks that undergo either kind of split have a tendency to be volatile for a number of reasons.

Companies that perform reverse splits, which are usually lower-value stocks belonging to companies looking to meet exchange listing requirements or increase the perception of value, can behave pretty consistent moves in the days following the split. Some of this volatility can be chalked up to the market reassessing the stock at the new share float and discovering price.

However, another aspect of the somewhat predictable price action in reverse split stocks is due to over-eager short sellers who assume that the reverse split is a sure sign of a struggling company. They then take a short position in these stocks expecting them to drop quickly. That’s when other traders often come in and squeeze them out, driving the price higher as some of the short sellers attempt to close out their position.

This can be a reliable strategy, which is why I like to keep stocks that have undergone a reverse split in the past couple weeks on my watchlist. However, I also pay attention to the stock’s relative volume as well as the amount of short interest in those stocks.