Small Cap Stock Considerations
Stockscores Foundation for the week ending November 27, 2023
In this week's issue:
In This Week’s Issue:
- Market Outlook – Small Cap Stocks are Starting to Turn
- This Week’s Market Minutes video – Every Investor Needs to Watch This Chart
- Trader Training – Small Cap Stock Considerations
- Strategy – Stocks in Play
Market Outlook – Small Cap Stocks are Starting to Turn
Stocks continue to build optimism, consistent with the seasonality of the market which tends to be strong from now until the Spring. Large Cap tech stocks have been the strong performing group but Small Cap stocks probably have the best upside since they have lagged so much. The key for the Small Caps is stability in interest rates. This has started to develop over the past few weeks making the lower priced stocks a place to look for opportunities. Be patience, as it takes time for downward trends to reverse. Watch for stocks breaking downward trends, forming rising bottoms and then making an abnormal break to the upside from this optimistic pattern.
This Week’s Market Minutes video – Every Investor Needs to Watch This Chart
If you are invested in the stock market, you must watch this chart if you want to time your entry into stocks. This week, I show the chart to watch, then provide my analysis of the markets overall and look at the trade of the week on MRAI.
https://youtu.be/TQJh2_O_ONk
Click here to watch this week’s video
Trader Education – Small Cap Stock Considerations
Investors often group stocks by their market capitalization, the total value of the company based on the price of their shares multiplied by the number of shares outstanding. Microcap stocks might have 20,000,000 shares out with a price of $0.50 - these tend to dominate the TSX Venture Exchange. A company with a few hundred million is more of a real business but still considered a small company compared to the large cap stocks that dominate the major market indexes, each valued at many billions of dollars. Apple, currently the largest company listed, has a market cap of $2.97 Trillion.
There are significant differences in how stocks small cap stocks trade compared to large caps. It is important to understand these differences so you can approach trading the in the right way. Here are some things to consider:
Liquidity - liquidity is a measure of how actively a stock trades and how smooth the price movements are for a stock. Generally, large cap stocks are more actively traded and make less volatile changes in price. Small cap stocks don't have as many investors which makes them subject to a higher level of price volatility. This means that the reduced liquidity of small cap stocks makes them riskier. A stock that does not trade actively can make big price swings because of the actions of one large investor.
From a practical standpoint, this means you can suffer a bigger loss than you plan for in your risk management. You may plan to exit a trade if the stock hits your stop loss point at $5. However, if the stock is not very liquid and many investors try to exit at the same time, you could end up getting out at a much lower price than what you had planned for.
Correlation - every stock has some correlation to what the overall market is doing. If the general market is going up in value, most stocks will also go up. Large cap stocks tend to be more closely correlated to the market index. If you look at a chart comparing Microsoft (MSFT) with the Nasdaq 100 (QQQ) you will find that they move all most exactly the same way.
This makes it important to analyze the market index as well as the stock when considering the purchase of large cap stocks. Even if the large company you are considering is doing great things in its business, it may not perform well if the overall market heads lower.
This also means that large cap stocks can outperform small cap stocks when the overall market is strong. We have seen this over the past year; small cap stocks have been flat while the large cap stocks have moved in a strong upward trend with the overall market.
If the overall market breaks its long term upward trend, we may see money look for market beating returns in small cap stocks because this group is not so closely correlated to what the overall market is doing.
Performance - small cap stocks have a greater capacity for percentage return, up or down. Smaller companies tend to have a less diverse business which means they can go up or down rapidly based on the performance of their products or services. Consider how a company making a smart watch would do if it was successful. For a company like Apple, the launch of a smart watch might bring in a few billion dollars in sales but that, in the context of their overall business, will not have a huge impact on earnings. If a small cap company had the same success with the same product (and it was their only product), the effect on their stock price would be massive.
Of course, the failure of a business can also have a huge effect on share price. We often see small cap biotech stocks suffer painful and sudden sell offs when a drug that they are developing fails to get approval.
This defines the risk reward trade off that comes with selecting between market caps when investing. Large stocks have a hard time significantly beating the overall market. Small caps can achieve this but they can also suffer significant losses. With smaller cap stocks, risk management is more important.
Yield - many investors like stocks that pay a dividend since they rely on their portfolio for income. Most small cap stocks are working to grow earnings and use their capital to reinvest in their business. Once companies get large, they begin to return their earnings to shareholders as dividends. If you want to collect dividends, you will generally focus on larger cap stocks.
Fun - historically, I have found that trading smaller cap stocks is more fun. It is enjoyable to buy a stock at $5 and watch it go to $10 in a few days. That percentage gain can happen with small cap stocks, it is rare with large caps.
Of course, making good returns is always going to be fun and you ultimately have to go to where the trend is strong. Smallcap stocks have been trending lower as interest rates were rising but are starting to turn around now that interest rates are stabilizing.
Back To Top
Day and swing traders should focus on stocks that are in play. We can define these stocks by abnormal volume and very actively traded. When a stock is trading more volume than normal with a very high number of daily trades, it has attracted a crowd and deserves to be watched for breaks from predictive intraday chart patterns.
This week, I ran a Market Scan for abnormal volume and a high number of trades and found two stocks that I think are worth watching for day and swing trades over the next few days.
1. RDHLRDHL traded over 300,000 times with very abnormal volume today. It may pullback in the very short term as it jumped up into a downward trend but the stock is worth considering on a break of a pullback on the 13 minute chart.
Back To Top
2. AFRMAFRM broke to new highs for the year with good volume today and traded 267,000 times.
Back To Top
