We’re used to thinking big. We try to achieve something big enough to feel good about ourselves. Thinking of stock markets, we tend to follow the same pattern, sticking to corporate giants like Google or Amazon, Netflix or Microsoft. However, dealing with stock markets, sometimes it’s worth thinking small.
Investing in shares of large, established companies may be a safe and sound strategy. However, it may take months or even years to profit. If you want to grow your portfolio in a faster way, you’ll have to consider trading other types of stocks – including small-cap stocks – with higher volatility, as they could bring you quicker and greater returns (with the higher risk of losses).
What are small-cap stocks?
Small-cap stocks represent brilliant opportunities to trade rapidly growing companies and potentially achieve good profits.
An important metric in trading, market capitalisation – or market cap – determines a company’s size and its total market value. Market caps help traders to identify stocks of various sizes and diversify their investment portfolio accordingly.
According to market-cap calculations, companies are divided into several size categories, ranging from nano- or micro-cap stocks (including penny stocks) to small, mid, large and mega-cap companies. Today, a company is considered small-cap if its market capitalisation stands between $300 million and $2 billion.
Even if $2 billion might not seem like a small amount to you, compare it with companies that have a market cap of $200 billion or higher.
Small-cap stocks vs large-cap stocks
By the way, size is not the only difference between small and large-cap stocks.
One of the major differences is stability. Large-cap companies would seldom grow at an accelerated pace because they are already established and have firmly occupied their seat in their respective industries. Usually the companies whose names you hear most often in the news, such as Tesla, Disney or General Electric, are recognised as large-cap.
Considered relatively reliable and stable, large-cap stocks are capable of delivering long-term but slow returns. They may also attract investors seeking significant dividends.
Far less established than large-cap companies, small-cap stocks may potentially bring a quicker rate of return. However, they are considered to be riskier investments.
Why is the risk is bigger? Small-cap companies are still growing. They don't have a proven trade history. With limited data available about the company, it's much harder to determine the stock's price trends and patterns.
Another characteristic that makes small-cap stocks different is seasonality.
Depending on the time of year, the performance of small-cap stocks may differ from the performance of stock giants.
Generally speaking, small-cap stocks enjoy a higher growth rate than large-cap stocks. However, in different parts of the year, they may perform poorer or better. They tend to be stronger at the beginning of the year, probably due to the “January effect” – the time when stocks reach their all-time highs after the holidays. This also happens as a consequence of usual December sell-offs, when traders get rid of their losing assets.
However, as the year progresses, small-cap stock performance may weaken against the popular large-cap stocks.
Advantages of trading small-cap stocks
There are several specific benefits attributed to small-cap stock investing:
Benefit of global trends
Trading small-cap stocks, you can also benefit from the same trends that affect large-cap stocks. Statistics show that since 1994, in 78% of months when the S&P 500 index went down, the S&P SmallCap 600 joined its downward movement. Therefore, you may apply the same trends working with large-cap stocks to the small-cap stocks, catching emerging trading opportunities.
Opportunity for everyone
Many big investors are sure that the small-cap stock list doesn’t deserve their attention. Considering it a waste of time, they believe small-cap stocks to be too risky and volatile.
This is actually true. Small-cap stocks are highly volatile and risky. However, it makes low-priced small-cap stocks extremely rewarding. They create opportunities for ordinary people with less competition.
Large space for growth
The smaller the cap, the higher the growth potential. Usually offered by less notorious companies, small-cap shares have a big potential for growth, as the company’s earnings and revenues increase as time goes by. Becoming more popular among the general public, these stocks experience higher demand. If you’re lucky to be ahead of the crowd, you can make a good profit out of this growth as a trader.
How to find the right small-cap stocks to invest in
Want to be among the first to discover outstanding opportunities of lesser-known small-cap stocks? Follow some basic tips:
Use technical analysis tools
Stock market trading is not a random gamble. To make thorough decisions, you need to be well-prepared. Technical analysis helps you to see a clear picture of a stock’s past, present and even future performance to get you ready for possible future movements.
You can never be 100% sure of how the stock will move in a minute. Analysing stocks through various technical indicators and timeframes, you’ll notice that some patterns happen over and over again. Once you identify them, you’ll be able to use them for your benefit.
Use fundamental analysis
Though a chart-based or technical analysis strategy is extremely important while analysing the stock, there is another method of research which can also contribute to success – fundamental analysis.
Searching for the best small-cap stocks you may not find a lot of data for thorough technical analysis. In this case fundamental analysis may help to determine whether a stock is worth trading or not.
While technical analysis is completely about numbers, fundamental analysis offers you information about the company’s background and performance. Very often, technical and fundamental analysis work hand-in-hand.
Track volume and news catalysts
If you decided to invest in small-cap stocks, don’t forget to look at some stock indicators, which may help you to make the right choice. When looking for trading opportunities with small-cap stocks, be ready to check up the stocks’ trade volume and related news catalysts.
Volume is extremely important. In order to find an easy way to enter and exit the trade, you need to be sure that there are enough small-cap shares traded on a daily basis. Otherwise, you risk to be stuck in a dead market. If you can also track an upcoming event – such as an earnings report – that can influence the stock price, it may become a great trading opportunity.