Low-liquid Stocks are An Unjustified Risk or an Opportunity to Make Good Money?
Like any other type of goods,low-liquid stocks have such properties as supply and demand. The more developed and well-known the issuing company is, the more in demand its securities are and the greater their volumes are traded on stock exchanges.
The presence of stable supply and demand makes it possible to establish current market prices as a result of an equilibrium between these two driving forces of the market. Prices set in this way, as a rule, have a minimum spread (the difference between the buy and sell prices of the same stock). This is typical of highly liquid stocks.
A small digression: it is customary to call such financial instruments (in this case, stocks) liquid in trading, which can be bought and sold without any problems and with a minimum spread.
As for low-liquid stocks, the situation is exactly the opposite. Their issuers are usually little-known, relatively small companies or newly formed startups. Investments in such securities are much more risky, and therefore less popular. This is the reason for the relatively low demand for them.
Due to low demand, such stocks cannot boast of sufficiently flexible pricing. Their price changes in leaps and bounds and has very large spreads. Such stocks are not only difficult to sell, but problems can also arise when buying them (especially when it comes to large enough volumes).
It would seem, what is the problem here? If, with low demand, no one wants to buy such securities, then the market should welcome a casual buyer “with open arms” by filling him up with unnecessary securities from head to toe.
This is partly the case, but one problem arises. When the purchase of such securities begins in large enough volumes, their prices rise by leaps and bounds and the buyer has to pay more and more in order to gain the volume he needs.
How a simple American schoolboy made $ 800,000
Low-liquid stocks are much more sensitive to changes in the current supply and demand for them precisely because in most of the time their values ??are very small. There is a story about how an American schoolboy earned $ 800,000 from them, starting with a start-up capital of $ 8,000. The name of this prodigy is Jonathan Lebed. He started trading at the age of 12 and in the first year and a half was able to increase his capital to $ 28,000 (almost 500% of the profit).
At the same time, the boy was busy filling his own website about trading, where, along with the official exchange news, he published his own forecasts regarding the future prices of certain securities. Soon enough, his website became a fairly popular resource and the boy noticed that his forecasts were beginning to have a rather strong impact on the low-liquid market.
When he advised to sell, prices went down, and when he recommended to buy, they went up. Well, how not to take advantage of this alignment? And Jonathan began to deliberately manipulate the market (not bad for a student, right?).
This kind of manipulation could not go unnoticed for a long time, and pretty soon the Securities and Exchange Commission (SEC) became interested in Jonathan’s brokerage account. Quinoa was accused of fraud, but even here he was not so simple.
He stated that, firstly, all his forecasts were absolutely sincere, and secondly, he did not impose on anyone to act in accordance with the recommendations given to him.
As a result, the SEC managed to chop off $ 285,000 from him (they also took a promise from him not to misbehave anymore) . That was the end of the matter, and the boy was left with half a million dollars in his pocket and continued to work on the trading path. Now he is not engaged in manipulation (at least no one caught him on this).He trades honestly, including acting as a financial analyst and selling his investment ideas and forecasts to everyone.
Earning strategy on low-liquid stocks
I in no way urge you to engage in manipulations like the hero of the story described above. Moreover, in our time, such a trick is unlikely to work. Pamp and Dump schemes are now increasingly used in the cryptocurrency market, but in the stock market this is no longer possible (or at least very difficult).
However, the main property of illiquid stocks, thanks to which such manipulations with them were generally possible, remained unchanged. Namely, the increased sensitivity of their prices to changes in the balance of supply and demand.
And thanks to this property, it is relatively easy to calculate the transactions of institutional investors and join the price wave that they raise. At a time when a large investor or, say, a trader of a transnational corporation begins to acquire a large batch of low-liquid stocks, their price will start to rise. An increase in demand will cause an inevitable rise in prices, but this growth will be limited by the exchange rules.
The fact is that in order to avoid “Pamp and Dump” situations, the price growth for each specific financial instrument is artificially limited. After the share price, pushed by the buyer, rises during one trading session by 30-40%, the exchange floor will fix it at this level, not allowing it to rise even higher.
Such price fixation is likely to cause a decrease in supply, as most sellers would prefer to wait for the next trading session to begin and further price increases. This scenario will continue exactly as long as the institutional investor does not pick up the required volume of shares, sometimes it can last for several days in a row.
This very wave of growth can be used in order to join it at the inception stage and exit with a profit at its very top (when the buying of shares stops). In this case, you can use this simple algorithm of actions:
- We set up the trading terminal to track growth leaders, filtering out low-liquid stocks that have risen in price by 30-40% per day;
- At this level, we make a purchase, remembering to set the Stop Loss level and wait for the start of the next trading session;
- As a rule, if a large investor continues to buy shares the next day, then the price can quickly jump by another 30-40%;
- We fix the profit or move the Stop Loss up and wait for the next trading session.
As you can see, the strategy is quite simple, but at the same time it should be understood that it is also quite risky. Here, in no case should you be greedy and leave on time so as not to end up with a bunch of unnecessary papers in your hands.