Trading Micro-cap Stocks

Micro-cap stocks are stocks that are priced below $5 per share. The description of microcap stocks is sometimes used to include stocks whose values are far below $1 per share; the so-called nano stocks.

Microcap stocks and nano stocks are traded on the Over the Counter Bulletin Board (OTCBB) or Pink Sheets markets, which houses stocks of companies with market capitalisation of between $50 million and $300 million. Many of these companies in reality are either companies undergoing bankruptcy or are companies with virtually no assets.

The microcap stocks are clearly not for long term investment, but rather for short-term speculation. Traders who want to benefit from microcap stock trading should be prepared to catch the price movements early as most of the time, such movements consist of sharp spikes. These spikes occur because a little buying activity in a stock that is thinly traded will definitely cause some price activity.

What a Trader Requires for Microcap Stock Trading

First, the trader needs to open an account with a discount stock brokerage firm. Most discount brokerages allow traders to open cash accounts with $500 and margin + cash accounts at $2000. After the trading account has been activated, the trader can login to the online stock trading platform provided by his broker, and click on the links that will take the trader either to the OTCBB market or the Pink Sheets market. There, all the stocks listed in these categories will be displayed and the trader will have the opportunity to trade any of these stocks.

There are several order types that can be used to trade microcap stocks. Traders have the choice of using market orders (not usually recommended) and pending orders such as limit orders, stop orders, Good Till Cancelled (GTC) or Good till Day (GTD) orders.

There are two commission structures that are operational in this market.

  1. The per share commission structure charges traders per share that is purchased. This is useful for those who are purchasing a low number of shares.
  2. The per trade commission structure charges traders a flat rate for each trade made on the market, irrespective of number of shares purchased. It is useful for those who intend to buy a large number of shares, especially if trading nano stocks.

Problems with Microcap Stock Trading

The commonest complaint with microcap stock trading is fraud. Microcap stock fraud occurs commonly in three ways:

a)     Stock dilution through unending reverse stock splits. This creates a new large pool of outstanding shares which are sold and the proceeds simply go into the coffers of the company owners. This is very prevalent and many companies involved in this scheme really do not have any assets on ground.

b)     The so-called “pump and dump” schemes where stock investment gurus who have actually been paid by these companies, use the marketplace to issue misleading information that creates an impression of an undervalued company with a much higher intrinsic value. This drives share prices high, and the company owners and their cohorts who promote the stocks dump their shares on the new entrants, making money off the deals and leaving those who bought high to deal with the eventual price collapse.

c)     Non-fulfilment of profitable exit orders. Even though potentially there is the opportunity to double, triple and even quadruple earnings in a single trading day, the real state of affairs is that sometimes the trades are not executed at set profit targets. Reasons adduced for such occurrences are legion, but insufficient liquidity to satisfy the trade order is one common reason given by brokers for not fulfilling client exit orders.

These problems are very real and occur very regularly. As a trader interested in trading microcap stocks, you will need to take a lot of precautions to prevent some of the nasty occurrences in this market from clearing off your money.

How to Safely Invest in Microcap Stocks

Microcap stocks, particularly nano stocks, theoretically have no bottom. It therefore means that the only way to get the best pricing (i.e. buying at a potential low) is by using a limit order. With a limit order, your order is only filled at the stipulated price. It is either a price you are comfortable with, or not at all. The risk of buying at market price and then have the investment go to the dogs by a plunge in price is therefore reduced.

Some companies listed in the Pink Sheets market are not listed there because they do not have high market capitalisation, but it could be as a result of their being listed abroad. Baby food giants Nestle and Nissan are examples of strong foreign companies that are listed on the Pink Sheets exchange. These two companies release their numbers periodically and so investors will have a basis on which to buy their stock. You should have no business trading companies without financial records.

Always set a limit order as your profit target, so that your trade is closed automatically when the trade has achieved your profit target. There is really no way of catching a price spike, so let your order do it for you.

When selecting the commission plan, use the per trade commission plan as opposed to the per share commission plan. If you use the per share commission plan for nano stocks, you will end up paying far higher than you should in terms of commissions for trades.

Diversify your portfolio. Do not put all your money in nano stocks. Stocks priced between $1 and $5 per share will still deliver the same kind of returns as the nano stocks and because of the heightened activity by true market participants (as opposed to pure speculators) and the enhanced volume of trading in shares priced within this range, there is a better chance of profitable trade exits being fulfilled.

So if you have the risk appetite to attempt to make some good money from trading microcap stocks, you can try them out on the OTCBB and Pink Sheet markets.