Low volume stocks are stocks that have an average daily trading volume of not more than 1000 shares. Low volume stocks are usually associated with smaller companies that are trading on the over the counter stock exchanges though there are a few that are also traded on the major stock exchanges.
Most low-volume stocks are thinly traded and therefore are known to trade irregularly at significantly low volumes. There are several risks associated with low volume stocks that you should know about as an investor, before deciding to trade. Here are some of the noteworthy risks associated with trading low-volume stocks.
Firstly, there is the risk of trading difficulties due to low liquidity. Low-volume stocks lack liquidity, which is the ability to buy or sell the security in the stock market at any time without significant changes in market prices. Low liquidity leads to a high bid-ask spread thereby increasing the probability of losing money.
Second, low-volume stocks come with unpredictable stock returns. These stocks are associated with small companies whose stocks are traded on over the counter exchanges where they are not obligated to maintain certain minimum requirements like full closure of necessary information to investors.
Thirdly, low-trading volume stocks are often an indication of trouble for the respective company; signaling that there is possible deterioration in company reputation. Deteriorating company reputation negatively impacts the company’s stock’s returns thereby imply a higher risk of loosing for the investors.
Fourth, trading low-volume stocks significantly expose you to fraud and stock marketing misconduct. Trading low-volume stocks expose you to dishonest stockbrokers and salespersons that may exploit you by claiming to have certain insider information and lying to you about prospects of high returns, which will never materialize at the end of the day.
Fifth, trading low-volume stocks make you targeted prey for pump-and-dump-scams. Certain company promoters may use insider information about a company’s valuations to periodically artificially inflate prices and offload their shareholdings to unsuspecting investors who later lose their investments when the stock prices later plummet.
In conclusion, Low volume stocks are not always traded in good faith. The low liquidity makes them difficult to dispose of and they are also susceptible to legal or illegal stock manipulation and other forms of stock market fraud. Traders or investors are advised to always exercise caution and conduct prior due diligence before purchasing low-volume stocks.