What are Thinly Traded Stocks: How Do They Work, Benefits & Risks

Key Highlights

• Thinly traded securities refer to stocks with low trading volume, indicating fewer buyers and sellers.
• These assets are less liquid and more volatile, carrying higher risk compared to more actively traded securities.
• These stocks are typically less known and receive less media attention, making it challenging to gather information and assess their value.
• Despite the risks, trading them can offer benefits like potential short-term appreciation and opportunities during market downturns.

How Do Thinly Traded Shares Work?

Both a low volume and huge bid-ask spreads indicate thinly traded assets. These assets generally carry a somewhat higher risk than investments that are liquid. Thinly traded securities are frequently found outside of national stock markets, as was previously indicated. Because of this, there are typically greater differences between the asking and bidding prices when there are fewer willing vendors and buyers.

The price of the security itself may change significantly if a seller sells at a lower bid price or a buyer buys it at a higher ask price. These securities are riskier than liquid assets because a liquidity risk might arise from the lower number of participants as they can more readily affect the market price.

Characteristics of Thinly Traded Securities

What you should know about stocks that are lightly traded is as follows:

High Liquidity

Low liquidity is one of the characteristics of sparsely traded securities. This implies that there are fewer suppliers and buyers on the market. Therefore, it causes price volatility to increase and bid-ask spreads to widen. Consequently, it might be difficult for traders to locate counterparties at the prices they want while trying to purchase or sell lightly traded assets.

Diminished Public Appeal

Since sparsely traded stocks are sometimes overlooked by experts and investors and receive less media attention, obtaining information about them and determining their worth may be difficult.

Elevated Volatility of Prices

Even a small number of buy or sell orders can have a big influence on the price of assets because of the low trading volume. As a result, investors may face both possibilities and hazards due to this increased price volatility.

Benefits of Thinly Traded Stocks

Trading in thinly traded securities can offer several Benefits:

Short-Term Appreciation: These equities might appreciate quickly in the near term. Even a little rise in demand might result in major price increases when these stocks catch the eye of investors. A stock that trades 2,000 shares a day, for instance, would see a spike in demand to 10,000 shares per day if it is positively covered by a credible financial magazine. This would quickly increase the share price. Early investors may make significant returns in this situation.

Opportunity During Market Dips:During market downturns, thinly traded equities can be repurchased at deep discounts. A sparsely traded stock's price may drop if a sizable number of its shares are sold since the increased supply may exceed the increased demand. If you would want to purchase additional shares of this kind of asset, keeping an eye on the price during market downturns may present a chance to do so at a reduced cost.

These advantages demonstrate how trading sparsely traded stocks may be profitable, providing chances to purchase additional shares at reduced prices during favorable market conditions and the possibility of significant short-term returns. It's crucial to remember that sparsely traded companies can also be riskier and more volatile, so thorough due diligence and risk management are necessary before making any kind of investment in them.

Risks Associated with Thinly Traded Stocks

Trading these stocks has its risks:

Greater Risk: Investments that are liquid are less risky than equities. They might not be as predictable and stable as more actively traded equities. 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. Limited Liquidity: Limited liquidity is a common problem for equities. Investors may find themselves in a tough situation if selling the investment at all turns out to be impossible under certain circumstances.

Should You Invest In Thinly Traded Securities?

Securities with little trading volume might be a risky investment. Trading these assets is riskier and more difficult than normal because of their decreased visibility and probable undervaluation, which provide significant potential rewards. Buying these shares is a decision that is influenced by your research skills, investment objectives, and risk tolerance.

An excellent addition to their portfolio with lucrative returns may be considered by seasoned investors who are prepared to put in additional time and effort for due research. Moreover, novices must act with caution or consult an expert.

Conclusion

Trading these assets is a high-risk, high-reward way to take advantage of significant volatility in tiny trading volumes. Due to the erratic nature of these investments, one may profit from increases in value over the short and long terms.