Low-Volume Stock Trading Risks
Small-lot stocks are those with a daily trading volume of less than 10,000 shares. While many other market conditions and considerations can be taken into account, investing in companies with small transactions is one of the riskiest investments an investor can make.
There are several reasons why an investor's portfolio may be at risk when investing in small-batch stocks.
Lack of liquidity in small lots is the biggest risk. Trading stocks is impossible without sufficient liquidity, defined here as the ability of an asset to be bought and sold freely on the open market without its price fluctuating significantly.
Small batches of stock are often more difficult to sell quickly at a competitive or desirable price. Besides liquidity, there are many other considerations for small-lot stocks. These difficulties include:
Low trading volume is often a symptom of a lack of interest among market participants, which enables them to charge higher prices when trading such stocks in the market. Therefore, these holdings may indicate higher profit potential than is actually achievable.
On the other hand, selling a small amount of inventory could require flooding the market with a lot of inventory, which would cause prices to plummet, especially if demand remains historically low. When liquidity is tight, the average trader often loses the money they have made.
This could indicate a bad reputation for the company.
Although perceptible across all price ranges, low trading volume is becoming typical of microcaps and penny stocks.
On the OTC market, many of these companies have less corporate transparency. Low trading volume usually indicates that a company's reputation is deteriorating, which can negatively impact a stock's return potential.
This may indicate that a company is still in its infancy and has yet to establish itself.
Believe In The Big Picture
Unanswered questions may relate to the low trading volume of the stock, such as possible reasons for the lack of interest or a larger audience for trading such stocks.
If the company's management, facts, goods, services and finances are not fully transparent, low transaction volumes may be due to irregularities or violations of the law.
Identifying all the different explanations for low volume provides the big picture that is critical to increasing the future return potential of a stock. Subsequent trading in the company's stock will be affected if any of the possible explanations are not in compliance.
Final Thoughts: Despite stumbled across a small lot stock and thinking it's a rough diamond, the truth is that there's a good reason why small lot stocks aren't usually traded: Very few people are interested.
Despite the prospect of future appreciation, their lack of marketability makes them difficult to sell.