How does anyone make significant money on very low volume stocks?

Question

After getting some answers to a related question, I thought I'd post a follow-up. It seems that if there is a low-volume stock, even with significant daily swings in stock price (e.g. 10-15%), one really can't take advantage of that to make any significant amount of money. In the previous post, I outlined a naive trade intended to make $1,000 off a $10k buy, but it was shown this would likely fail, even if the stock price would have increased by 10% had I not placed the trade. Another way to state this is that my trade would disrupt the stock price, and not in my favor at all.

So, that means I'd have to settle for a smaller trade. If I bought $100 worth of the stock, that size of a buy wouldn't be too disruptive. I might succeed and get $10 out of the trade (10% of $100). But my trade fee was $8 or so, so I only made $2 on this trade, despite the stock price changing by 10%, which is very high. I'd have to repeat this process 25,000x/yr in order to make $50k/year as a swing trader in this way. Maybe with computers I could do that, but it seems unlikely.

So, I would think there is some middle number between $100 and $10k that will produce a better return. However, I've shown that I cannot expect to get $1,000/trade. Probably not even $500/trade. So let's say I can make $200/trade. I'd still have to do this 250x/yr to make $50k/yr swing trading. That's about 5x/week, with no losses. Totally unrealistic.

So how do people make any significant money trading low volume stocks--if they even do? I assume money is made, since the stocks are bought and sold. I have some guesses, but I'd like to hear from the experts.

Answer 1

First, I want to point out that your question contains an assumption.

Does anyone make significant money trading low volume stocks? I'm not sure this is the case - I've never heard of a hedge fund trading in the pink sheets, for example.

Second, if your assumption is valid, here are a few ideas how it might work:

1. Accumulate slowly, exit slowly. This won't work for short-term swings, but if you feel like a low-volume stock will be a longer-term winner, you can accumulate a sizable portion in small enough chunks not to swing the price (and then slowly unwind your position when the price has increased sufficiently).

2. Create additional buyers/sellers. Your frustration may be one of the reasons low-volume stock is so full of scammers pumping and dumping (read any investing message board to see examples of this). If you can scare holders of the stock into selling, you can buy significant portions without driving the stock price up. Similarly, if you can convince people to buy the stock, you can unload without destroying the price. This is (of course) morally and legally dubious, so I would not recommend this practice.

Answer 2

Because swing trading isn't the only reason to buy a stock, and it's not the only way to make money on a stock. I do not have the expertise to make advice one way or the other, but I personally I feel swing trading is one of the worse ways to invest in the stock market.

To answer your specific questions:

In the previous post, I outlined a naive trade intended to make $1,000 off a $10k buy, but it was shown this would likely fail, even if the stock price would have increased by 10% had I not placed the trade. Another way to state this is that my trade would disrupt the stock price, and not in my favor at all.

• That swing created by your purchase does nothing to change the fundamentals of the company you are investing in. If the company still has value over time, the swing will also be washed out over time.

So, that means I'd have to settle for a smaller trade. If I bought $100 worth of the stock, that size of a buy wouldn't be too disruptive. I might succeed and get $10 out of the trade (10% of $100). But my trade fee was $8 or so...

• If you believe a company is a good investment, then a fee of 8% of the capital you invested really is a terribly way to invest.

To summarize, you are completely correct that even hoping for gains of 10% on a consistent basis (in other words, after every single trade!) is totally unrealistic. You already seem to understand that swing trading on low-volume stocks is pointless. But your last question was...

So how do people make any significant money trading low volume stocks--if they even do? I assume money is made, since the stocks are bought and sold. I have some guesses, but I'd like to hear from the experts.

... and in a comment:

Then if no one does make significant money trading these stocks...what are they doing there on the market?

The answer is that the buying and selling is mostly likely not by swing traders. It's by investors that believe in the company. The company is on the market because the company believes public trading to be an advantageous position for them to receive capital investments, and there are people out there who think that transaction makes sense. In other words, real investing.