Micro-cap stocks are those of companies that have a market capitalization between $50 million and $300 million. A company’s market cap is the total market value of all of its outstanding shares. It’s calculated by multiplying the price of a single share by the number of outstanding shares.
Many micro-cap stocks are also penny stocks, and you can't follow the same strategy for investing in them as you would other stocks. Penny stocks have a per-share price of less than $5. Here are some tips to help you learn to trade penny stocks.
The risks of trading micro-caps and penny stocks
Before we get started, you should understand that it's very risky to invest in penny stocks and micro-caps for several reasons. For example, micro-caps and penny stocks are typically extremely volatile, so they are generally riskier than companies with larger market caps. Additionally, there is often very little public information about them available, making it difficult to judge which ones have a bright future and which ones don't.
Because their market cap is so low, liquidity is often a problem because it can be difficult to sell your shares. Fraud is also a strong possibility with micro-caps and penny stocks due to the many pump-and-dump schemes that mar the space.
You should watch out for red flags like trading suspensions or stock promotions. Any unexplained increases or decreases in the stock price or trading volume are also a cause for concern, as is a lack of operational success and if insiders own large amounts of the stock. You should also watch out for companies that have no real business operations.
How to trade penny stocks: the basics
Penny stocks and many micro-caps trade on unregulated stock exchanges and are often targeted by pump-and-dump schemes. Thus, it can be extremely difficult to research them. You have to be careful of what you read about micro-caps because it might be a promotional stock scam.
Most micro-caps are traded over the counter instead of on the New York Stock Exchange or the NASDAQ. They're traded on the OTC Bulletin Board, which is regulated by the Financial Industry Regulatory Authority (FINRA).
All companies traded over the counter must meet the minimum standards of financial reporting. Some penny stocks are listed on the Pink Sheets instead, which means they don't even have to meet those requirements. The problem with trading stocks on the Pink Sheets is that there is very little information upon which to base your trades.
Different levels of penny stocks
The micro-caps that are the best to own are traded on major stock exchanges like the New York Stock Exchange and the NASDAQ. These stocks are usually trading at less than $5 per share, although they may trade a little higher than that.
You'll get a good idea of whether it would be wise to buy these stocks because companies must meet all the reporting requirements associated with being listed on a major stock exchange. They report the same type of information mid-, large- and mega-cap companies report.
Traditional penny stocks trade between 1 cent and 99 cents, and they are found on the OTC Bulletin Board or the Pink Sheets. Some stocks trade for less than a penny per share, and they are never found on the NASDAQ or New York Stock Exchange.
It's important to note that just because a stock falls below $5 per share, it doesn't necessarily make it a penny stock. For example, Ford dipped below $5 per share in April 2020, but that didn't make the company a penny stock. It also didn't qualify as a micro-cap.
The New York Stock Exchange and NASDAQ have a minimum required market cap, so when stocks fall below that level, they are delisted and moved to the over-the-counter market. Stocks can also be delisted and moved if their per-share price falls too low for too long. Most stocks listed on major exchanges are not penny stocks.
How to identify the best micro-caps
You should always research a stock before you invest in it, although, as mentioned before, it can be challenging to research penny stocks. If you can't find the information you need to be confident in the company, you probably shouldn't invest.
There are some things to look for when considering micro-caps. For one thing, you must be able to tell that the company is either making money or will be able to make money in the near future. Some of the most expensive stocks are those of money-losing companies, but it's because investors see potential in them. They make money on an adjusted basis and invest in growth, which is why they lose money.
You also need to look for companies with assets or cash, which will enable them to withstand difficult times. Additionally, any company you invest in should have a strategy for growth. Penny stock companies should have some ideas in mind to grow their business so they can get listed on a major exchange.
If you're trading penny stocks on your own, you'll want to use stock screeners to narrow down the wide list to just those that fit the characteristics you're looking for. Some common filters include volume, performance, price, volatility and chart patterns.
You also want to look for stocks that have positive news headlines and a float of less than 100 million. The float is calculated by removing the number of shares held by insiders and employees. Additionally, if the relative volume is high, it means investors are actively trading the stock. Many penny stocks see very little action, so you want to avoid those. High volumes mean there is plenty of liquidity in the stock, making it easier for you to unload your shares if you desire to do so.
You should always be careful when trading micro-caps or penny stocks. It is too easy to lose your entire investment if you aren't careful.