Learn the difference between penny stocks and micro-cap stocks, plus the potential risks of such investments, to help you decide if you should consider them.
Micro-cap stocks typically have market capitalization between $50 million and $300 million
Micro caps aren’t highly correlated with the broader market and can offer diversification and other benefits, but also risk that can be greater than that of the broader market
When compared to shares of larger, more well-established companies, trading penny stocks or micro-cap stocks is often viewed as a riskier trade, and there are bona fide reasons for that. Penny stocks and micro-cap stocks are typically less liquid, more volatile, and carry higher risk than traditional stocks traded on established exchanges. They can also be the realm of scammers. Buyer beware.
So why trade them? Penny stocks are definitely not for everyone, but some traders have a bit of the risk taker inside them and thus have a bigger appetite for risk. Still, for some retail investors, it’s worth learning a few basics about penny and micro-cap stocks and keeping an eye on these under-the-radar nooks and crannies of our markets. Let’s consider a few questions.
Micro-caps typically have market capitalizations between $50 million and $300 million (stocks under $50 million are often called “nano caps”). Micro-caps may be listed on an exchange or trade exclusively over-the-counter. For comparison, the 30 stocks on the Dow currently have an average market cap of over $200 billion.
A penny stock generally trades at less than $5 per share, according to the U.S. Securities and Exchange Commission (SEC), and typically trade exclusively over-the-counter.
Many penny stocks are issued by new, startup companies with no proven track record. Some have no assets, operations, or revenue, or their products and services may be in development or have yet to be tested in the market, the SEC notes. Other penny stocks may have been “blue chip” stocks in a prior life, but fallen on hard times, and others may be established companies that simply have a low stock price.
Another risk involves low trading volume, “which may make it difficult for you to sell your shares when you want to do so,” the SEC says. Because they’re so thinly traded, “any size trade can have a large percentage impact on the price of the stock,” the regulator says.
In addition, because some of these companies may not regularly file reports with the SEC and haven’t met strict listing requirements to trade on major exchanges like the NYSE or Nasdaq, there’s often little information available on these businesses. That’s why they may be susceptible to fraud and manipulation, the SEC says.
Many penny stocks trade on so-called “pink sheets” or the “over-the-counter bulletin board” (OTCBB), which are basically electronic stock quotation services that enable companies not listed on a major stock exchange to trade. Penny stocks can be traded through many brokers, including TD Ameritrade.
Find your best fit.
Market professionals may follow the Russell Microcap Index, which includes more than 1,300 exchange-listed U.S. companies in Financial Services, Health Care, Technology, and other industries.
As of January 31st, 2021, companies in the index had an average market cap of about $1.8 billion.
Micro caps comprise less than 3% of the entire U.S. stock market, according to Russell indices, which means the performance of these companies doesn’t usually correlate highly with the rest of the market. That can create potential diversification benefits. But keep in mind the reputation for risk is well earned.
Through micro-caps, investors can also gain exposure to young but potentially large, rapid-growth industries—biotechnology, for example.
Investors in biotech micro caps, for example, scrutinize management strength, capital structure (especially debt), pipeline opportunity, and whether the company may be acquired or otherwise link up with a bigger company.
Clearly this tiny slice of the market is not for everyone, but for those considering micro caps, it’s important to go in with eyes wide open, aware of the risks, and having done your homework.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2022 Charles Schwab & Co. Inc. All rights reserved.