Great Things Can Come in Small Packages: The Pros and Cons of Small Cap Stocks

Great Things Can Come in Small Packages: The Pros and Cons of Small Cap Stocks

Small cap stocks tend to have a poorer reputation than other market segments. Smaller companies are perceived as having more volatile prospects and being more prone to bankruptcy or other serious complications. However, small caps also offer some of the best growth opportunities for listed shares, and can often be purchased at a fraction of their potential value.

Successfully trading small cap stocks requires an understanding of those characteristics that define them. With that in mind, here is a brief guide to small cap stocks that will provide you with the information that you need to begin to investigate this area of the equity market.

What Is a Small Cap Stock?

A small cap stock stands for ‘small capitalization’, which is any company with a total value of between $250 million and $2 billion. Small cap stocks can be traded anywhere, but they tend to trade on OTCBB or the Nasdaq because these exchanges have lower listing requirements. Small cap stocks are not ‘penny stocks’, and there are many that trade at over a dollar per share.

The Pros of Investing in Small Cap Stocks

Huge Potential for Growth: Small cap stocks represent small companies, but not all of them are small for structural reasons. Some of today’s small companies will go on to become the industry behemoths of tomorrow, and if you got in on the ground floor of tomorrow’s titans, there is a good chance that you just secured your retirement. Not all small caps will go on to become industry leaders, but they are out there waiting to be found.

Retail Advantage: It is difficult for large institutional investors to make adequate absolute returns in the small cap market because of the enormous amounts that they need to invest to see a position pay off. This mans that even if they have the professional capacity to identify small cap winners, they are limited from acting on this information due to their relative size. This leaves small retail investors the opportunity to find great trades that the big institutional investors cannot be bothered to deal with.

The Cons of Investing in Small Cap Stocks

Higher Risk: Small cap stocks have a much higher risk of poor performance or outright implosion than larger companies traded on the major exchanges. This risk exposes you to a much greater potential for significant losses than if you were to trade in standard equities.

Time and Effort: Information and analysis for larger companies is widely available, often for free or for a nominal charge, whereas analyst coverage for small cap stocks is slim to none. This means that investors in small cap stocks need to learn to do their own research, which can be very time consuming and difficult, especially when compared to the ease of researching standard equities.

A Small Cap World of Potential

Small cap stocks represent a great potential for retail investors, as they have the ability to find valuable stocks that trade at a significant discount. However, this potential comes with the drawbacks of increased risk and a much greater investment of time and effort. Trading small cap stocks is not something that you dip in and out of, but is rather a niche market that requires time and dedication to master.

For those who do learn to master the intricacies of small cap stocks, however, the potential trading profits are substantial.

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