Investor's Corner: Volatility Just One Drawback Of Thin Stocks

Thin is another term for a stock that trades in relatively small amounts of shares.

In IBD, stocks with average daily volumes of under 100,000 shares are generally considered thinly traded.

One problem is that light stocks can get knocked around more than those with heavier volumes, just like tents don't fare well in a windstorm.

It's a lot harder to shake a stock, up or down, when hundreds of thousands or millions of shares are changing hands.

True, some thin stocks can race higher a lot faster than those with huge daily turnover.

But higher volatility can make it difficult to hold a stock. You could be shaken out with an 8% loss quite quickly with a slim stock.

Volatility is one reason institutional investors tend to shy away from thinly traded issues.

Also, you'll find few institutional investors owning thin stocks. Limited liquidity makes it challenging for any major investor to acquire a meaningful stake.

When a stock trades, say, 50,000 shares a day it's difficult for a fund managing millions of dollars to move in and out of it.

If the manager wants to exit the stock, selling that relatively large stake would take considerable time. By the time the position is liquidated, the stock may have plummeted.

Without the buying power of funds and other institutions, a stock is deprived of a potentially huge source of demand. Remember, it's institutional investors that drive the bulk of trading on Wall Street, not individual investors.

The adjacent table shows the most successful stocks so far this year that also have high Composite Ratings. Five of the 24 best have average daily volumes of less than 100,000 shares. Expand the list to the top 60 and 10 are thin names.

With many foreign-based stocks, a thin daily average isn't necessarily bad. These stocks float a portion of their shares in the U.S. So some foreign companies that trade less than 100,000 shares a day actually have large market capitalizations.

To find the average daily volume, check IBD Charts at investors.com. The figure is shown on the upper portion of each daily chart. Also, average volume in plotted by a thin line that runs over the volume bars.