Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific investment advice, including stock trading advice that can help you reduce the risk of more aggressive investing. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Thin-trading stocks can produce good results if you can manage the risk and identify stocks with real growth prospects.”

Many speculative or aggressive stocks may trade a few hundred to a few thousand shares daily. That’s why they are called “thin” or even inactive traders compared to the hundreds of thousands, if not several million shares trading daily for a Canadian bank or a major utility, for example.

You’ll find some stocks like these among our recommendations in Stock Pickers Digest, our newsletter for aggressive investing. Here’s what you should know about them.

With fewer transactions taking place in their shares, thin traders are often more volatile than actively traded stocks, especially in reaction to unforeseen news. These stocks may also have a wider spread between the bid (what you get if you sell “at the market”) and the “asked” (what you pay if you buy). The spread may be 2% to 4% or more, compared to 1% or less for an active trader.

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Selling more shares and attracting more attention

This wider spread is more of a cost than a risk. Every time you buy and sell, you have to absorb the bid/ask spread as a transaction cost, on top of brokerage commissions. If you trade actively, these costs add up.

It’s less of a problem if you hold for a year or two, or longer, as we generally advise.

Speculative stocks are often thin traders because they have few shares in public hands, or because brokers don’t do research on them. But, as they grow and prosper, they may sell more shares and attract broker attention. If so, trading expands, the spread shrinks, and this increase in liquidity makes the stock more attractive to successful investors. As a result, the stock price may go up.

That’s one reason why we include some thinly traded stocks in with our Stock Pickers Digest recommendations. The best thinly traded stocks have the potential to graduate into the ranks of the more actively traded, and this gives them slightly more profit potential than established stocks, albeit at a cost of extra risk.

We try to help reduce that risk by being careful about what we recommend. But paying attention to how much a stock trades is one of many important indicators in picking successful stocks.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

Have you achieved good results with any thinly-traded stocks? Have you had disappointing results with them? When you bought the stock, were you concerned about the fact that it was less liquid and potentially more volatile? Let us know what you think.