Should You Gamble on Less Active Stocks?
Wynn Resorts (WYNN) has gotten a lot of attention recently, to a large extent because of its growth in Macao, the largest gaming region in the world. How much does institutional buying affect the stock when it makes important announcements or releases earnings? Probably a lot: Wynn only trades 2 million shares a day, so in theory, the sale of big blocks of shares could move the stock a great deal. Wynn's 52-week high/low is $72/$151, a very wide spread.
Similarly, retailer Costco (COST) trades only 2.4 million shares a day. Monthly sales data can move this stock a great deal in a short period of time because the shares are thinly traded compared to other large retailers. Costco's stock rose from $70 on March 16 to $78 on April 7, thanks to excitement about improved earnings. Does it matter that the large change in the number of shares it trades when it issues results tends to move its stock price more than might be the case with a widely traded competitor like Walmart (WMT)?
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Street Directory recently made the argument that if investors want some degree of price stability, they should buy stocks which have heavy daily trading volumes. "Stocks with a high volume are very liquid, not to mention they have lower spreads between the bid and ask prices. Technical analysis works best on liquid stocks because trends are more fluid and give more data on which to base a decision," its article pointed out. Stocks with less liquidity tend to experience more price swings on volume spikes. For example, a small biotech that releases good news can rise 50% in a day as traders move into the stock.
Is the argument that highly liquid stocks are more stable than those with fewer shares true? Probably, because the fundamentals of supply and demand rule trading as they do most economic transactions.
But this leaves the investor with a decision: Does he prefer the potential of sharp moves up or down that comes with a stock whose normal daily volume is modest? The risks involved are considerable, but so are the potential rewards.
Investors who would rather count on a stock's tendency to trade within a relatively small range should stick to the "most actives." These are usually large companies that also tend to pay dividends -- another source of steady returns. The most active list usually includes the largest banks, such as Bank of America (BAC), and multinationals like GE (GE), Microsoft (MSFT), and AT&T (T) -- stocks that are unlikely to be roller coasters.
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