Part One of Learn How to Invest in Small Cap Stocks and Make Triple Digit Profits

 Part One of Learn How to Invest in Small Cap Stocks and Make Triple Digit Profits

Every day, a new firm like Dell, Microsoft, or eBay files for an IPO, promising to make the early investors in its shares extremely wealthy over the course of several years. Finding them and making safe investments in them is the tricky part. With the debut of a fantastic product or service, General Electric or Microsoft might see a 30% or 40% increase in share price in a single year; nevertheless, the likelihood of making 70%, 100%, or even 300% with large cap businesses in a single year is relatively low. This isn't the case with micro and small-cap stocks, though. Indeed, there will be a micro- or small-cap stock every month that no one has heard of but will make a ton of smart investors extremely wealthy.

Thus, the question is: How can one trade riskier equities like these? Here are five guidelines that you should never break. I will go over the first rule in Part I of this series.

First rule: finish your homework.

When you discover a micro or small cap stock that piques your interest, be sure to conduct thorough research before deciding to invest. Investigate a small stock's float at all times. Why does this matter? for several reasons. Let's think about this situation. You look at a tiny stock ABC that you find quite appealing. You see that ABC has only $10MM in shares that are issued, a $5MM float (with insiders holding the remaining $5MM), and an average daily volume of $3.7MM for the previous three months. Given that the average daily volume is 75% of the float—the total amount of shares owned by the public—you might be in for a pretty rough ride. Just this revelation can cause you to rethink your stock purchase.

Furthermore, you must ascertain when the lock-up period for stock ABC expires if it has recently undergone an initial public offering (IPO). Insiders are typically prohibited from selling their shares for six months following an IPO. Assuming that four months have passed since the IPO, let's take another look at our fictitious stock, ABC. Companies' share values frequently begin to decline two months before to the end of a lock-up period, as insiders are expected to sell off their holdings and flood the market with volume once they are able to do so lawfully. An overnight doubling of the stock's float is certain to dilute the price of stock ABC, maybe very quickly, if the market is trading relatively flat and there is no additional demand just before insiders offload their shares. All that's going on here is supply and demand. Now, there is twice as much stock available on the market as there is demand for it.

But let's examine the other side as well. Let us examine XYZ, a business with $20MM in outstanding shares and a $17MM float. Up until the insider lock-up period expires, positive news about firm XYZ has continuously increased the stock price. Assume for the moment that despite the steady price increase, the insiders still choose to cash out and sell off $2.5MM of their shares right away. The limited float of this firm combined with great demand could lead to a purchasing frenzy that would push prices up even faster if more shares are released.

To sum up, the first tip is to always conduct your research and learn as much as you can about the stock you are purchasing. As I've shown, a tiny float can have a negative impact on a stock's price in one scenario while having a positive impact on the price in another.

In the upcoming installments of this series, I'll go over the final four rules.

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