Untapped Demand Could Fire-Up These Stocks
Ultimately, the basic reason a stock moves up or down is supply and demand. When there are more buyers than sellers, the stock goes up. When there are more sellers than buyers, the stock goes down.
Sure, you can often point to event X or event Y to explain a stock’s movement. But no matter what, an event changed a stock price because it changed supply and demand for the stock.
For example, if a company issues a bad outlook, its stock will get slammed. The bad news makes the stock less attractive. It causes many shareholders to dump the stock at the current price and causes some potential buyers to reconsider and wait for a lower entry point. In other words, at the current price point, there are more sellers than buyers. Therefore, the stock price falls.
Running Out of Buyers
This basic idea of supply and demand is why technical traders pay attention to trading volume. When a stock rises on strong volume, it means a lot of buyers are coming to the table. On the other hand, when trading volume starts to fall as the stock rallies, it typically means that demand is starting to dry up as the stock reaches higher prices. It could be a sign that the stock is peaking.
After all, when there are fewer and fewer investors willing to buy a stock at a certain price, the stock price will have to be lower to attract more buyers. Put another way, when investors who want to buy a stock have already bought the stock, it will be harder and harder to find new buyers.
This is one reason why lesser known stocks, such as small-cap and even micro-cap stocks, carry more untapped potential.
Unlike the household names like Apple (NSDQ: AAPL) or Amazon (NSDQ: AMZN), small- and micro-cap stocks don’t get anywhere near the same following. These stocks don’t have many (or any) analysts that cover them. As a result, many of them fly under the radar.
Everyone who participates in the stock market knows about AAPL and AMZN. If they don’t buy them, it’s because they think their prices have gotten too high.
On the other hand, when a stock isn’t widely known, this means that there are potential buyers on the sidelines who might buy the stock if they knew about it. As a result, there is a good chance that the stock is undervalued.
Open Up the Gates
So what could shine a light on under-the-radar stocks like this?
It could be a breakthrough that makes the news. It could be new coverage initiated by a prominent analyst that brings the stock to the attention of investors. Whatever the case, the effect would be like opening the gates to a new market for the stock.
But of course, investing in tiny stocks isn’t a “can’t fail” strategy. Small companies may not have proven products and they may not have the financial resources to weather a protracted downturn.
Moreover, while being relatively unknown means there is a large untapped pool of potential buyers, there is also downside. There is usually not much publicly available information on small stocks, especially micro-cap stocks. This makes them vulnerable to manipulation, such as “hit pieces,” where short sellers first short a stock and then publish an article attacking the stock.
This is why you will rarely see any short sellers go after established blue chip companies with hit pieces. If someone accuses Apple of fraud, no one is even going to bat an eye. But if the same person does the same to a tiny company, because of the relative lack of certainty, the short attack is much more likely to be successful, at least over the short term.
Thus, while small- and micro-cap stocks offer tremendous potential upside, you still need to pick out quality. My colleagues at Radical Wealth Alliance do just that, on a regular basis.
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