All About Microcaps, Part 1: Dangerous or Profitable?

All About Microcaps, Part 1: Dangerous or Profitable?

What are microcap stocks?

In the United States, publicly-traded companies are categorized based on their capitalization: nano, small, medium and large.

Companies that have less than $300 million in maximum capitalization are called microcaps. Microcap stocks have a minimum capitalization of $50 million while nanocap stocks have even less than $50 million.

Our main focus, apart from general investment tips, are microcap stocks. 

What’s the main difference between microcap stocks and stocks from publicly traded companies with larger capitalization?

The marked difference lies in two things: risk and return. Publicly traded companies such as Intel have large capitalizations and generally provide small gains over a period of time.

A day trader can take advantage of smaller ROI because his money has a lower risk of disappearing due to sudden dips in stock prices. Unless there’s an impending stock market crisis, a portfolio or medium-cap or large-cap stocks shouldn’t be too hard to manage.

And then we have the microcap stocks. Some years ago, day traders swarmed the Internet for hot tips and leads for microcap stocks. The environment was decidedly toxic for first time traders because there were many unscrupulous individuals who were trying to manipulate microcap market by creating artificial “stampedes” through rumor-mongering.

Today, the environment for microcap stocks has become friendlier and there’s more information available for first-time traders. Beginners wouldn’t have to fear microcap indices anymore!

But the question remains…

Why invest in microcap stocks in the first place?

Earlier we talked about risks and returns… These two are the driving forces behind the continued interest in microcap stocks. You see, microcap stocks may not necessarily be cheaper than stocks from publicly traded companies with large capitalizations, but the potential returns are much larger.

Should you drop everything and invest your life savings in microcap stocks?

Unfortunately, the answer is no, that’s actually a bad idea. Microcap stocks may be relatively more profitable than large-cap and medium-cap stocks, but the risk of losing your money is also much higher. The potential ROI is huge in some cases but the risk goes up along with this investment possibility. 

Experts have long warned the public that microcap stocks and nanocap stocks should be cautiously approached because of their volatility. Volatility of individual stocks can be computed but generally speaking, microcap and nanocap stocks experience much higher dispersions.

If a stock has a higher dispersion range that simply means that the value of a given stock can wildly increase or decrease for the duration that it is offered to the public. These wild fluctuations can offer the possibility of tremendous ROI or massive losses in the short/long term.

How is the stock market doing this year?

As of this writing, the US stock market has made a fair recovery and day traders have been able to make good ROI in the past few months. After the microcap bust a few years ago, microcap stocks have also been recovering, much like large-cap stocks that have recovered more than 20%.

Why aren’t companies and organizations investing more in microcap stocks?

Despite the fact that microcap stocks offer a higher ROI potential, day traders and big investors are not easily drawn to them. Here’s why:

  1. Investment Potential – Due to the high volatility of microcap stocks, they are generally deemed as poor investments compared to medium-cap and large-cap stocks. Big investors are drawn to pricier stocks that have low volatility.
  1. Trading Volume – When the trading volume of a particular stock is low, big players will stay away from it. Usually, it’s the microcap stocks that have lowest trading volumes compared to higher cap stocks.
  1. Stock Price – Traders that represent larger corporations are often barred from buying stocks that have a trading value of $1 or less.

Institutional policies are the biggest hindrances even if a fund manager sees great potential in any microcap stock. Even a visible upward trend over a period of months will not be able to bend institutions policies regarding nanocap stocks and microcap stocks.

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Despite the “bad rap” that microcap stocks suffer year after year, day trading experts are aware that some microcap stocks perform fantastically, too. Of course, there are even some instances when a microcap stock finally graduates from the pink sheet domain and is able to explode upward to the medium-cap or large-cap indices.

Though this occurrence is rare, it’s no impossible. No one can really tell when a microcap stock will finally graduate but when it does, expect a stock’s volatility to manifest itself in the next few months.

Read More: All About Microcaps, Part 2: DOTCOM and NASDAQ Tales


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