Stock Market Tips: Overview of Small Cap Stocks

Small Capitalization Stocks are stocks that contribute to no more than $1 billion dollars of a company's equity. The value of a company's capitalization is commonly calculated by multiplying the number of a company's outstanding shares by it's share price or average share price. There are also micro-capitalization stocks that have even lower amounts of equity capitalization, but this article will focus on Small cap stocks. A few of the general features of small cap companies are as follows:

•Smaller share prices on market exchanges
•Subject to higher risk from larger competitors
•Greater growth potential
•Potential stock price volatility

Benefits and Risks:

Each capitalization class of stocks have certain advantages and disadvantages associated with them. Some tend to be higher risk whereas others tend to be lower risk. These benefits and risk also vary depending on the economic sector in which the asset class is bought or sold. An overview of the benefits and risks associated with small cap stocks is provided below:

Benefits of Investing in Small Cap Stocks:

Small cap stocks are cheaper to buy than mid cap and large cap stocks. What's more, small cap stocks under $5.00 per share are not as well studied by financial analysts. This can be an advantage as a company may be undervalued due to this media deficit. Also, since these stocks represent smaller companies, there is more potential for earnings to grow at a larger percent than a well established company with strong market positioning. Since these companies are smaller, they may also be acquisition targets for larger companies which is often good for a stock price.

Risks of Investing in Small Cap Stocks:

Since small cap stocks are cheaper to buy, one can buy more of them. What's more at a lower cost per share, any decline in value is a proportionally greater percentage loss of invested capital than with a higher priced stock. For example, if person A owns 100 shares of Berkshire Hathaway Class A shares and Person B owns 1000 shares of Little Cap's Are Us Corp. and Person A's shares cost $100K per share and Person B's shares cost $10 per share, person B is going to experience a far greater investment loss if his or her shares decline $1 than if Person A's shares decline $1.

Risk Avoidance Techniques:

The risks associated with Small Cap stocks can be mitigated through investment strategies or trading tactics. In an investment strategy an investor may choose to diversify one's small cap investments by purchasing several small cap companies across several industries and/or purchasing a large cap competitor in the same industry. This reduces the risk of investment loss should one company go belly up in competition. In terms of trading, long positions can be hedged with short positions and short positions can be hedged with put options. While risk mitigation reduces the potential for loss it may also inhibit potential gains. A few of the risk mitigation methods one may utilize when investing in small cap stocks are as follows:

•Diversify across multiple industries
•Select only small cap companies with proven financial strength
•Purchase mutual funds that specialize in small cap companies

Tips to consider when investing in small capitalization stocks:

Investing in Small Capitalization stocks is generally for investors and traders with at least some taste for risk. For this reason it is important to utilize a well thought out entry and possibly exit strategy. Below are some techniques to stabilizing an investment strategy:

Stop Loss: By not allowing stocks to decline by more than 10% investors are in effect risking no more than 10% of their capital per investment.

No Emotion: Emotional investing is shunned by some professional investors. Emotions can cause one to sell a stock that is about to rocket or buy a stock that is about to tank. Using logic and exercising fiscal discipline helps one manage money unemotionally and can reduce risks associated with emotional investing.

Research: Due diligence is a hallmark of fundamental stock analysis. If it's done right, it can probably reduce risk if accompanied by good decision making.

As with most investments, risk is always a factor that can only be minimized but not always eliminated. Many investors have experienced loss at one time or another. Even large brokerage firms, high-powered investors and sophisticated investment computing algorithms are not completely immune to unexpected events in the World and economic markets. Nevertheless, investment in small capitalization stocks can be profitable and the potential for profitability may increase by utilizing the information in this article.