:max_bytes(150000):strip_icc():format(jpeg)/shutterstock_67023106-5bfc2b9846e0fb005144dd87.jpg)
Trading in low-volume stocks can be highly risky. They typically have a daily average trading volume of 1,000 shares or fewer. They may belong to small, little-known companies that trade over-the-counter (OTC) but they can also be traded on major stock exchanges.
Low-volume stocks remain outside of the purview of mainstream traders and investors and they lack general trading interest. Their low volume can lead to a lack of liquidity and ease in price manipulation. Smaller and newer companies can go belly up and leave investors with nothing. There can be great rewards in the same place you find great risks, however. Some strategies for trading in low-volume stocks might result in a profit.
Key Takeaways
- Trading low-volume stocks can be risky but there are also rewards to be had if you have the right strategy under your belt.
- Assume the market-maker role with thinly traded stocks and consider multibaggers.
- Watch for corporate actions and macroeconomic factors to affect trading volume.
- Investors may benefit from low trading volumes that arise as a result of temporary events and the rise of the overall market.
- Exchange-imposed changes or initiatives have the potential to shoot up returns.
What’s Your Approach?
Decide on an approach before venturing into low-volume stocks. Are you in it for short-term trading gains or are you investing long-term in a little-known company that you believe in? Short-term traders can quickly reap profits from the sporadic price movements of low-volume stocks.
So few shares are usually traded that it doesn’t take much to drastically change the price of the stock. But there’s always a risk that you can’t buy or sell the stock for maximum profit due to the stock’s lack of liquidity.
Long-term investors in low-volume stocks should be adept at assessing a company’s business prospects. Research the stocks well and understand the company before investing. Experienced traders know that many little-known companies frequently list on OTC stock exchanges to raise money but only a few succeed in the long run.
Individual Profile
Consider assuming the market-maker role with thinly traded stocks. A market-maker selects one or two stocks and offers to buy and sell them by quoting bid and ask price. This individual facilitates both buying and selling to maintain liquidity.
The trader can take advantage of low liquidity in this role by offering wide bid-ask spreads to the trading counterparts and pocketing the difference. Be sure to have a backup plan, however, and take a more limited position rather than piling up a huge inventory that you might not be able to offload.
Multibagger Potential
Microsoft (MSFT) and Infosys (INFY) may be huge names but their stocks weren’t that well-known at one point and they traded at very low volumes. Investors who managed to pick them young either through luck or robust stock analysis were able to multiply their investments many times. They picked what some in the financial industry call “multibaggers.”
The term multibagger refers to a company whose stock increases in value multiple times over from its original value or the bag. Someone whose original investment of $1,000 multiplied to $10,000 has a 10-bagger.
Long-term windfall gains are a distinct possibility in low-volume stocks for investors who understand an industry well and do their research.
Benefits of Corporate Actions
Not all stocks have a low trading volume because of their popularity. Some may trade this way because of their very high stock price. Berkshire Hathaway’s Class A stocks (BRK-A) were trading at the astounding price of $693,880 per share as of Oct. 23, 2024. The average trading volume is only 1,017 shares per day. Seaboard (SEB) trades at $2,984.77 per share with an average daily volume of only 921 shares.
A corporate action like a stock split with stocks like these can lead to lower prices and higher trading volumes. The result is increased liquidity and higher market participation where returns can be substantial. The challenge remains predicting when corporate actions will occur.
Macroeconomic Factors
Low-volume stock trading can also be a result of local or global macroeconomic factors. A country may be going through a slowdown or recession with higher interest rates and inflation. Such periods often see overall low stock trading activity. Stocks that were thinly traded before the recession fare even worse.
Recessions and slowdowns almost always abate or reverse if they’re given enough time. Experienced investors can use excess capital to invest in cherry-picked winners that will perform with high returns in the long run.
Make sure you consult a financial professional regardless of your trading strategy or goals.
Temporary Events and Phases
The uncertainty around major events such as political upsets, strife, or extreme weather can be an opportunity to benefit from low-volume stocks. India’s 2004 general election results were accompanied by a major drop in stock prices when a coalition backed by Communist parties was the only available option for government formation.
Investors who picked up stocks on doomsday saw their low-priced purchases triple in under four years. A few of the best performers were little-known, low-volume stocks that saw up to 15-fold returns.
Benefit From Overall Market Rise
As the saying goes, “When markets rise, everyone makes money.” The overall market rise may be a result of stable government, easing oil prices, or other local or global developments. Low-volume stocks often stand to benefit the most in cases of such an overall market rise.
Exchange-Driven Changes
Exchange-imposed changes or initiatives have the potential to shoot up the returns from thinly traded stocks, offering substantial profit opportunities to risk-favoring investors. Bats Global Market, one of the largest stock exchanges in the United States, put forth a proposal to concentrate low-volume stocks on fewer exchanges in 2015. More moves like this can increase the liquidity of low-volume stocks.
What Is Over-the-Counter Trading?
Over-the-counter trades aren’t made on centralized exchanges. They take place between two parties without a regulator’s oversight, typically through broker-dealer networks.
What Does It Mean When a Stock Is Thinly Traded?
“Thinly traded” is another term used to describe a low-volume stock. Buyers and sellers are few and far between so an investor who holds this type of stock most likely won’t be able to sell it promptly.
What Is a Stock Split?
A stock split occurs when a company divides each existing share into multiple shares. A stockholder would end up with three shares for each share they owned if the company did a 3-1 split but this doesn’t increase the overall value of their holdings. Each share drops in value so the overall value remains the same.
The Bottom Line
Trading low-volume stocks is a risky game. Potential benefits are subject to many factors that are outside the investor’s control. The best bet is for an investor to take a long-term perspective. Invest with excess money that you may not need and select stocks that have good business potential.
Disclosure: Investopedia does not provide investment advice; investors should consider their risk tolerance and investment objectives before making investment decisions.
