In the Stock Market, Size Matters
Dear Penny Stock Millionaire,
When it comes to stocks, size matters.
As a trader, I focus on low-priced stocks because of their high volatility. However, this style of trading isn’t for everyone: Many traders prefer to take longer positions with more stable large-cap stocks.
Large-cap stocks are offered by big, established companies. While the share price may not move as sharply as a stock offered by a smaller company, there’s often plenty of room for growth – if you know what to look for.
Large-cap stocks offer traders the opportunity to benefit from the continued growth of industry leaders. Over the next couple days, you’ll learn all about large-cap stocks, including what they are, how to identify them, and the pros and cons of trading them.
What Are Large-Cap Stocks?
Before defining large-cap stocks, let’s clarify what “cap” means. When we start talking about caps in the financial realm, we’re talking about the market cap, or market capitalization.
Every trader should have an understanding of market cap because it’s an extremely important marker of a given stock.
Market capitalization is the total market value of a company’s shares outstanding. It’s designated in a dollar amount.
While you could (and should) look at a company’s sales and assets, the market cap gives you a different way to look at the size and scale of a company.
Good news: It’s ridiculously easy to figure out a company’s market cap. It’s determined by multiplying the total number of shares a company has by the current price per share.
So, for example, say Company X has 1 million shares, which are being sold at $50 each. That company has a market cap of $50 million. There are market cap calculators that you can find online, but come on. That’s easy math.
With the market cap number determined, you have a figure that can help you target your research and technical and fundamental analysis efforts to be most effective.
Figuring out the market cap helps you narrow down stocks of interest. For example, you might create a watchlist completely comprised of companies with similar market cap sizes.
Choosing stocks with different market cap sizes can help add diversification to your portfolio, too.
All right. Now that you know what market cap means, what does it mean to be a large-cap stock?
Once you’ve determined the market cap, the number you come up with will put the company in a variety of different size categories, ranging from nano- or micro-cap (these would be low priced stocks/smaller companies) to small-, mid-, large, and mega-cap companies.
While there isn’t an official delineation of the number that makes a stock fit into one category versus another, a large-cap company would typically be considered one that has a market cap between $10 and $200 billion with the market cap formula.
Yep, those are big numbers. That’s because these are big, established companies. Often, they’ve been around for a long time, or are in a major industry.
For example, General Electric, with a market cap of about $78 billion at the time of this writing, would be considered a large-cap stock.
Small Cap vs. Large Cap
What’s the difference between small and large cap? Here’s the 411:
You’ve probably already figured out that a small cap company is not as big as a large-cap company. But how big is the difference?
A large-cap company has a market cap between $10 and $200 billion. In comparison, a small-cap company falls between $300 million and $2 billion. That’s still pretty big, but tiny in comparison to the large-cap company.
If you’ve heard the term “blue chip stock,” large-cap stocks will often fall into this stock type category.
The term “blue chip” is actually inspired by the game of poker, where blue chips have big value. Blue-chip stocks are generally perceived as highly valuable stocks, which are prized for their ability to deliver long-term value.
They’re considered stable and secure. True, nothing is ever a sure thing in business or the market. But it usually takes a significant event to really make a big change in the stock price.
On the other hand, small-cap companies don’t always have the same perceived value because they’re not as established, well known, or trusted. They might be newer companies, or they might be in up-and-coming industries. They don’t have a proven track record yet.
There can be a big difference in the volatility of small- versus large-cap stocks.
In general, the higher the volatility, the bigger the risk. Small-cap stocks are usually a lot more volatile than large-cap stocks. These spikes in price mean you can potentially earn big profits, but it also means that you could easily experience big losses.
Because large-cap stocks have much lower volatility, you don’t have as much risk associated with rapid price movement.
Though it’s not always the case, small-cap companies are usually younger than large-cap companies. This means that there’s less company history and therefore less data to evaluate when performing fundamental and technical analysis.
With a small-cap stock, might be looking through a year or two few years’ worth of earnings versus the decades of data available with many large-cap stocks.
When to Buy
Small and large-cap stocks perform differently depending on the time of year.
When the new year starts, there’s plenty of optimism in the market. Traders are ready to go for the hottest new stocks unlike any other time of the year.
However, as the year progresses, small-cap stocks can go on the decline. In later quarters, traders are eager to cut losses which more frequently occur with small-cap stocks, and are more likely to hold positions in the more “sure thing” large-cap stocks.
There’s even a term for this phenomenon: the January Effect, which refers to the massive sell-off in December followed by lots of optimistic buying in January.
The Bottom Line
Like I said earlier, large-cap stocks aren’t my particular trading preference. I prefer the higher volatility provided by penny stocks. BUT I did start my trading career with large-cap stocks. The reason that I stopped trading them is the very reason some traders want to trade large-cap stocks. They are slow moving and very stable.
So if you aren’t trading on a daily or even a weekly basis and you are just looking to find a place to grow your wealth (slowly), then knowing how to trade large-cap stocks is a great skill to have.
Tomorrow, I’ll reveal the best way to find and trade large-cap stocks, as well as 3 different great large-cap stocks you should be looking at.
Editor, Penny Stock Millionaires