Most investors think of the major stock exchanges when trading stocks comes to mind. The New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotations (NASDAQ), and the American Stock Exchange (AMEX) are among those that first come to mind. Often overlooked by the mainstream media, microcaps are a low ticket security for companies that are valued at under five hundred million dollars and often trade in low volumes. These stocks also trade on ‘Over the Counter’ exchanges such as the OTCBB or Pink Sheets.
The very fact that small cap stocks trade at such low volumes increases the risks involved in investing in them. The Securities and Exchange Commission (SEC) urges traders of micro cap stocks to remember that these stocks typically trade with very low volumes on average. This makes finding buyers when you want to sell, and sellers when you want to buy more difficult. As a result, you may not get the stock at the price you want. This can result in buying too high
Despite the risks involved, micro cap stocks are often attractive investments to investors for various reasons. If you are new to investing and looking for the chance to return a high yield for a relatively low investment you are likely to come across some microcaps. The attraction often lies in the fact that at such low prices any changes are often measured by the hundreds of percent this means that your investment can literally double in one or two days time.
the price of small cap stocks can drop just as drastically and equally fast. Those who are inexperienced investors would do well to avoid microcaps until they have a better understanding of how things work. It is also important to note that because of the relatively low ‘worth’ of the companies that are often listed on the Pink Sheets they are often considered questionable investments. Some of these companies have such a limited financial history that no accurate determination of their actual value can be made. Many of these companies are either very new or dangerously close to bankruptcy.
There is also a strong potential for fraud with some buyers artificially ‘enhancing’ or driving the costs by buying large amounts of shares and raising the perceived value of essentially worthless stocks. Most traders who fall for this lose many when it comes time to sell.
A common definition for micro cap stocks is any stock that trades below $5.00 per share.
Penny stocks are not for everyone. Consider speaking to a financial advisor to see if trading small cap stocks fits in with your risk tolerance.
Before you decide to avoid microcaps, remember, that not all of them are ripe for fraud and manipulation. Many companies seek to expand the growth of their business by seeking out investors who are willing to fund that growth, in exchange for shares in future success. Many of these companies will find themselves off Pink Sheets listing and move onto larger exchanges.
Decreasing your risk is easy. Take the time to learn about the companies you are looking to invest in. If they know how to make money, you are buying a growing company. If you are looking at buying an idea, you may find your shares are not worth the paper they are written on. You need to be careful.