A significant portion of shares is trading in a thin market. They trade in irregular fashion or in small quantities. Investors must consider the substantial risk of trading these stocks with low volumes. Here, we discuss seven of the biggest risks.
Challenges in Profit Taking
A lack of activity in trading indicates that there is a lack of interest from a small number of market participants. These traders can be able to charge a premium for trading these stocks. Even even if one has the unrealized gains of the stocks, it might be difficult to collect the gains.
If you were to purchase 10,000 shares in a business for $10 each a year ago. Then the price increased to $13. This means that you’re enjoying non-realized profits of 30 percent. You’d like to sell your 10,000 shares and take home the profits. If the daily average trading volume of this company is just 100 shares it would take time to sell 10,000 shares at the market rate.
Selling your shares can also impact the prices of stocks with low volumes. The flood of the market with an enormous quantity of stock could cause prices to drop significantly in the event that demand remains at a constant low.
Low Liquidity Makes Trading Difficult
One issue with stocks that are low volume is the fact that they are not liquid which is an important aspect for stock traders. Liquidity is the capacity to purchase or sell a security on the market with no fluctuation in the price. It means that investors should be able to purchase and sell a security that is trading for $25 per share, in massive amounts, like 100,000 shares, and still remaining at the same cost of the shares at $25.
A lack of liquidity may be a problem for investors who are smaller as it can result in a large bid-ask spread. To overcome these challenges find the best trading app south africa. The average daily volume of trading can be a good gauge of liquidity. In general, frequently, traders who are frequent suffer losses when liquidity is poor.
Manipulative Market Makers
Market makers that are active in low-volume stocks may be able to use their low liquidity to earn. They know that the stock’s liquidity is low. This makes it possible to take advantage of buyers keen to enter and exit the markets.
For instance, a market maker could make an offer on 100 shares close to the price of sale and another offer for 1,000 shares at 10% lower than the price. If someone attempts for the sale of 1,000 shares at market price, they may only receive what they anticipated in the initial 100 shares and get a 10% discount for the remainder. It is essential to utilize limited orders for stocks that are low volume in order to prevent the risk of losing money.
Uncertainty About the Larger Picture
What are the actual causes of the limited trading volume for the stock? Why is there not much market or interest to trade this stock?
Other crucial questions are the following:
- What is an acceptable value for the shares?
- Are prices rising because someone purchased a large number of shares recently? Or is it the reverse?
- Are prices low due to an investor of hefty size threw stocks on the marketplace?
- Are the company’s shares involved in any irregularities which cause the shares of its company to become dangerous for traders?
Lack of transparency and the difficulty in determining prices makes it difficult to comprehend the full picture of low-volume stocks.
Deteriorating Company Reputation
While low volumes of trading are evident for stocks from every price segment They are particularly frequent for microcap firms or penny stocks. These companies are often traded through OTC marketplaces, which do not need to provide investors more information than companies that are listed on the major stock exchanges. Most of the time, these companies are brand new and have no record of success.
A decrease in trading volume could indicate an eroding reputation of the company that could further impact the returns of the stock. It could also indicate an unproven company that is yet to show its worth.
Vulnerability to Marketing Misconduct
Salespeople and brokers who are dishonest discover that low-volume stocks are excellent tools to make cold calls claiming to know the insider details of the next”ten bagger. Some other practices include releasing false press releases that lie about the prospects of large returns. Individual investors could be victims of these scams.
Susceptibility to Promotion
The company’s promoters are well aware of the true value of a company’s stock. Infrequently, low trading volumes cause short periods of artificially high prices. Promoters can then sell their huge shareholdings to ordinary investors.
In some cases, the situation could be a bridge between perfectly legal self-promotion to nefarious pump-and-dump frauds.
In reality, low-volume stocks don’t trade due to a good reason: only a few people are interested in them. They are not liquid, which makes them difficult to sell, even if the price appreciates. They are also vulnerable to manipulation in price and are attractive to fraudsters.