Risks of Trading Low-Volume Stocks — Yochaa (2024)

Investing in low volume stocks can put an investor’s portfolio at unnecessary risk for a number of reasons.

Typically, any stock that trades at fewer than 10,000 shares a day is considered a low-volume stock. While there are tons of market ratios and factors for investor to consider when investing in stocks to avoid risk and maximise profit, one factor that makes any stock riskier than it needs to be is investing in stocks that trade at low volumes.

Investing in low volume stocks can put an investor’s portfolio at unnecessary risk for a number of reasons.

The major risk associated with low-volume stocks is their lack of liquidity. And liquidity which is the simple ability for a stock to be traded easily in the market without a change in price is an essential element in stock trading.

Low-volume stocks are usually harder to sell quickly and at the market/desired price. In addition to liquidity risk, low-volume stocks have several other challenges that include:

Issues With Price Discovery

Low trading volume is often indicative of few interests from market participants, who can then command a premium for the trading of such stocks. As a result, these stocks may show a high unrealized profit than is practicable.

More so, selling low volume shares could may require flooding the market with a large supply of the stock which will cause prices to fall considerably especially if the demand remains at its consistent low level. Frequent traders often lose money when liquidity is low.

Could Signal Poor Company Reputation

Low trading volumes are increasingly common in low-priced stocks and microcap companies, although they can also be observed across stocks belonging to all price segments.

A lot of these companies trade on OTC markets with a low requirement on business transparency. Low trading volumes may be a clear indication of deteriorating company reputation which will further affect the stock return potential.

It could be indicative that a company is new, without proven track records and yet to prove its worth.

Uncertainty about the Larger Picture

There can may be unanswered questions surrounding the low trading volume of a given stock such as the possible reason for the lack of interest or wider audience for trading such stock.

The possibility of lack of transparency about company management, facts, products, services, and finances as the driver for the low volume as well as the possibility of the company’s involvement in irregularities or regulations violations.

Getting answers to all possible reasons for the trading of low volumes of a given stock provides the larger picture necessary to drive the future return potential for the stock. Any of the potential reasons being on the other side of the rules will affect the future trading of the company stock.

In conclusion, as tempting as it may be to stumble upon a low-volume stock and believe it is a diamond in the rough, the reality is that low-volume stocks are usually not trading for a very good reason—very few people want them.

Again, their lack of liquidity makes them hard to sell in spite of the promise of future appreciation. .

Written by Lawretta Egba

Risks of Trading Low-Volume Stocks — Yochaa (2024)

FAQs

Risks of Trading Low-Volume Stocks — Yochaa? ›

A Risky Proposition

They tend to be volatile, and they trade in low volumes, which means they're subject to price fluctuations from even relatively small trades. The low trading volume of these securities also can make them hard to sell due to a potential lack of buyers.

What are the risks of trading low volume stocks? ›

A Risky Proposition

They tend to be volatile, and they trade in low volumes, which means they're subject to price fluctuations from even relatively small trades. The low trading volume of these securities also can make them hard to sell due to a potential lack of buyers.

How to trade in low volume stocks? ›

The first step to investing in low-volume stock is to determine whether it is for short-term trading gains or a long-term investment. This, of course, requires that you carry out fundamental analysis to determine is the company is worth the stress or not.

Can low volume stocks be manipulated? ›

To protect yourself from market manipulation there are several steps you can take, some negative and some positive. Beware of low-volume stocks, as well as microcap stocks and penny stocks, They are far easier to manipulate than large-cap stocks or securities with high-volume trading.

What are the disadvantages of low liquidity? ›

Limited Investment Opportunities: Finally, low liquidity can limit investment opportunities for traders. In a market with low liquidity, there may be fewer opportunities to find undervalued assets or to capitalize on market inefficiencies. This can limit the potential returns for traders and investors.

What happens if trading volume is low? ›

Low trading volume is often indicative of few interests from market participants, who can then command a premium for the trading of such stocks. As a result, these stocks may show a high unrealized profit than is practicable.

What are the risks of thinly traded stocks? ›

Risks Associated with Thinly Traded Stocks

Challenging to Sell Quickly: It might be difficult for investors to sell equities rapidly when they own them. There could not be enough buyers owing to the low trading activity, which could result in losses because quick liquidation is required.

What is the minimum volume to trade stocks? ›

As a general rule of thumb, an Average Dollar Volume of 20 million or greater provides pretty good liquidity for most traders. If you trade a very large account (and accordingly large position size), consider an average dollar volume above 80 million to be extremely liquid.

Why do stocks drop on low volume? ›

Key Takeaways

Low volume pullbacks occur when the price moves towards support levels on lower than average volume. Low volume pullbacks are often a sign of weak longs taking profit, but suggest that the long-term uptrend remains intact. High volume pullbacks suggest that there could be a near-term reversal.

How much volume is good for trading? ›

Any level of volume that provides investors with specific insight into a security's price action (and a sense of the trading interest in that security) can be thought of as a good trading volume.

How to tell if a stock is manipulated? ›

If the company is generating revenue and has future growth potential, and still the company stocks are plummeting and trading, sometimes as low as its floor, then there's a high chance that the company stocks are being shorted or manipulated.

What is the punishment for stock manipulation? ›

Under Section 15HA of the SEBI Act, if any person indulges in fraudulent and unfair trade practices relating to securities, he shall be liable to a penalty of at least five lakh rupees but may go up to 25 crore rupees or three times the amount of profits made from the practices, whichever is higher.

Can a stock go up without volume? ›

An uptrend without increasing and/or above average volume suggests investor enthusiasm is limited. While the price could continue to rise, many traders who use volume analysis will nevertheless look for other candidates.

Why trading is not allowed due to low liquidity? ›

A lack of liquidity means that the bid and ask spread in the scrip is very high and can have an immediate adverse effect on your P&L. Consider the below illustration : Assume stock X is trading at Rs 100 and you decide to buy 110 strike price calls of this month (lot size 5000) expiry.

What is low liquidity risk? ›

Liquidity is a bank's ability to meet its cash and collateral obligations without sustaining unacceptable losses. Liquidity risk refers to how a bank's inability to meet its obligations (whether real or perceived) threatens its financial position or existence.

Is low liquidity good or bad? ›

Conversely, low liquidity implies fewer participants and less trading activity, which can result in higher price volatility and trading challenges. Liquidity risk, another important consideration, refers to the possibility of the market becoming illiquid rapidly, making it difficult for traders to exit their positions.

What happens when a stock gets too low? ›

If a stock falls to or close to zero, it means that the company is effectively bankrupt and has no value to shareholders. “A company typically goes to zero when it becomes bankrupt or is technically insolvent, such as Silicon Valley Bank,” says Darren Sissons, partner and portfolio manager at Campbell, Lee & Ross.

What does it mean when stock price goes down on low volume? ›

Rather than indicate a potential trend change to the downside, a decrease in price on low volume usually means that there's no consensus among market participants about a downward move. It may simply be a short-term pullback as investors close out positions to take some profits.

What is the problem with penny stocks? ›

Potential risks of penny stocks

Lack of liquidity: Penny stocks are often illiquid, meaning it can be difficult to buy or sell your shares quickly without impacting the price. Unprofitable: Many penny stocks represent a stake in a company that has not and will not generate earnings for its shareholders.

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