Thinly Traded Securities

Thinly traded shares are those which cannot be easily sold or exchanged for cash without a significant change in price. Thinly traded securities are often exchanged in lower volumes and have a small number of interested buyers as well as sellers. This can lead such securities to volatile changes in pricing when a transaction occurs.

Such securities have often been referred to as illiquid. Thinly traded securities basically trade at a lower volume and exhibit an increase in volatility. Often, thinly traded companies trade on exchanges that are over-the-counter.

How Do Thinly Traded Shares Work?

Thinly traded securities can be determined by wide bid-ask spreads as well as a low volume. In general, these securities pose a slightly greater risk than liquid investments. As mentioned earlier, thinly traded securities often exist outside the national stock exchanges. This is why the lack of ready sellers and buyers usually leads to larger disparities between the asking price and the bidding price.

Suppose a seller sells at a lower bid price or buyer purchases the security at a high ask price, the securities price itself can experience a significant move. Since the smaller number of participants easily impacts the market price, this makes way for a liquidity risk, making thinly traded securities riskier than liquid assets.

Characteristics of Thinly Traded Securities

• Limited liquidity: Thinly traded securities often have fewer buyers and sellers, which makes them harder to trade. This low liquidity can lead to wider bid-ask spreads and more price swings. It also means it may take longer to buy or sell these stocks at your desired price.

• Less public interest: These stocks usually don’t get much attention from analysts or the media. As a result, information about them is limited, making it harder for investors to research and accurately assess their value.

• High price volatility: Because trading activity is low, even a small number of buy or sell orders can cause sharp price movements. While this volatility may offer opportunities, it also comes with higher risk for investors.

Significance of Thinly Traded Shares

In thinly traded shares one sees larger ask/bid shares which generally signifies larger profits for a dealer. One of the key aspects of the bid and asking price is that the sellers receive the bid price while purchases pay the asking price. This distinction is how traders earn revenue using a bid-ask spread. The trader simply buys stocks at the asking price and sells them at the bidding price. Hence, the size of the spread is directly proportional to the size of the earnings made from it.

A bid/ask spread makes illiquidity easy to measure, but liquidity risk itself is harder to grasp and predict. The chance that the spread will grow to a concerning size always exists. The worst-case scenario is that the thinly traded security will have to be sold off quickly while the investor incurs a loss. Thinly traded securities can lead to more problems. If an investor can’t sell their shares, they might struggle to pay off their debts on time.

Illiquidity increases the credit risk of an investor. Investors who use a buy-and-hold strategy typically encounter fewer problems when thin trading since they aren’t generally interested in buying and selling securities quickly. This holds true for bond investors who are employing a buy-and-hold tactic, or those investors who are simply awaiting maturity from their bonds without being concerned about interim movements in price.

Advantages of Thinly Traded Stocks

There are some potential advantages of using thinly traded securities to trade. Firstly, there is the potential short-term appreciation seen in this thinly traded example. Suppose a thinly traded stock suddenly grabs the attention of investors, even a slight increase in its demand can trigger massive growth in the share price.

For instance, suppose a stock normally trades at 2000 shares a day, and a favorable article comes out about it in a reputable financial journal the following day. Demand could soar upto 10000 shares in a day just from that individual favorable coverage, driving the share price significantly higher in a few days alone. Ultimately, one can see large profits for those who chose to hold onto the thinly traded stocks before they gained popularity.

Secondly, there is the repurchasing of thinly traded stocks at bargain prices during market dips. This thinly traded example showcases how they can be repurchased at a bargain price. Let’s say an investor sells a huge percentage of their shares in a thinly traded stock. Following this, the price is likely to go down since the supply of the shares may likely exceed their demand. Suppose you intend to accumulate extra shares of a thinly traded security, watch for price dips so you snatch up the shares at a bargain price.

Risks Associated with Thinly Traded Stocks

• Higher investment risk: These stocks tend to be more unpredictable and less stable compared to actively traded shares. Their low trading volume can lead to sudden price changes, making them a riskier choice for investors.

• Difficult to sell quickly: Finding a buyer quickly can be tough due to low demand. This delay in selling may lead to losses, especially if you need to exit your position urgently.

• Limited market liquidity: With fewer trades happening, liquidity is often limited. In some situations, investors may struggle to sell their holdings at all, particularly during volatile market conditions.

Should You Consider Investing in Thinly Traded Securities?

Investing in thinly traded securities can be risky, as they are often less visible in the market and may be harder to value accurately. While they can offer attractive returns, trading them tends to be more challenging compared to actively traded stocks.

For experienced investors who are comfortable doing thorough research and have a higher risk tolerance, these securities might be a valuable addition to their portfolio. However, beginners should be cautious. It’s best to seek expert advice or build a stronger understanding of the market before investing in such stocks.

Conclusion

Thinly traded securities are a somewhat high-risk lucrative way to trade in low volumes but leverage high volatility. This way one can experience both short-term and long-term capital appreciation due to the volatile nature of these securities.

Explore the Share Market Prices Today

FAQs