What Is Thinly Traded?
Thinly traded securities are those that cannot be easily sold or exchanged for cash without a significant change in price. Thinly traded securities are exchanged in low volumes and often have limited numbers of interested buyers and sellers, which can lead to volatile changes in price when a transaction does occur. These securities are also known as being illiquid.
Thinly Traded, Explained
Most thinly traded securities exist outside of national stock exchanges. For example, many public companies listed on over-the-counter exchanges are thinly traded since relatively low dollar volumes are traded each day. The lack of ready buyers and sellers usually leads to large disparities between the ask price and bid price.
When a seller sells at a low bid or a buyer buys at a high ask, the price of the security can experience a significant move. Thinly traded securities are usually more risky than liquid assets because a small number of market participants can impact the price, which is known as a liquidity risk.
There are two ways to determine if a security is thinly traded:
- Dollar volume: This metric tells investors how many U.S. dollars are being traded on a given day. Securities with low dollar volume may be considered thinly traded compared to those with higher dollar volumes.
- Bid-ask spread: The difference between the bid and ask price is usually indicative of a market's liquidity. Thinly traded securities have a wider bid-ask spread than liquid securities.
Risks of Thinly Traded Investments
Thinly traded stocks aren't inherently bad investments, but they involve a greater level of risk than liquid investments. For example, many value investors that look for depressed opportunities may come across thinly traded stocks trading at a discount, but selling a position that doesn't work out can be extremely challenging at a good price.
Investors owning thinly traded securities may be forced to take a loss if they need to sell quickly. That is, they may not get the best price considering there’s not a steady supply of buyers. In some cases, it may not be possible to sell the security at all. Overall, the price of thinly traded stocks tend to be more volatile.
As well, many institutional traders and investors avoid thinly traded stocks since it's difficult to buy or sell stock without alerting other market participants that something is happening. Regulation-wise, many institutions can’t invest in thinly traded stocks because their buying activity would materially move the stock price.
Real World Example of Thinly Traded
The following chart shows an example of a thinly traded stock:
The volume in the chart appears as the bars overlapping the price. As you can see, the stock is traded over-the-counter and experiences dramatic price movements over time. While there are hundreds of millions of shares traded on some days, it's important to note that the stock trades at just over a penny, which means the dollar value of these trades is relatively small compared to larger blue-chip companies that trade millions of shares each day. In the case of a thinly traded stock, the price can be easily manipulated, which can put investors at risk.