Large Caps Vs Small Caps

Bob Iaccino, Chief Market Strategist and Co-Founder of Path Trading Partners, joins us live every Thursday from 11am ET, as our risk management educator.

With 30 years' experience working as an active investor in equities, commodities, futures and FX there are few better to talk on the subject of risk management.

Bob has developed a method for breaking down his key fundamentals of risk management, in a way that he thinks retail traders can understand and use to get actionable insights to bring into their own trading.

Below are some excerpts of Bob’s thoughts from a recent live session.

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What are the key differences between large caps and small caps in terms of trading?

With large caps, typically you're looking at market capitalization of 10 billion or more. There’s also a sector called mid cap. I would suggest a lot of you people that are struggling with small caps go to mid caps because you want more movement.

Small caps generally are defined as 300 million to let's say, a billion, so go between 2 billion and 9 billion and trade those if you're struggling with small caps, as you'll get a little bit more volatility. You'll get a little bit less liquidity than large caps, but you won't have the problem that the small caps have. That's market capitalization.

How do large caps and small caps compare in terms of risk management?

From a risk perspective, large caps are considered less risky. They don't move as much. Their business models are established and even earnings will not move their stock on a percentage basis as much as small caps would be moved from a poor earnings report. Small caps are more volatile and therefore riskier, although they don't have to be. However, they can be more susceptible to market downturns and sort of economic blips, for lack of a better phrase.

How does the growth potential differ for large caps and small caps?

Growth potential in large caps is steady, however, small growth in small caps is higher but unstable. You get a growth in a small cap. Stop stock. You can get 1530% growth, but you can also get the same in the opposite direction.

Remember risk and reward. They're inexorable. You can't separate the two. If you're looking for high rewards, you are accepting higher risk. Large caps tend to be steadier, but again, on a percentage basis, you're going to be like “Wow, Caterpillar moved 3%!”, if you position size correctly that could be a realistic difference, but you need a larger account to do that. This is why I'm suggesting mid caps for some traders.

In terms of liquidity, obviously large caps have outstanding liquidity. Nobody that I'm speaking to here or will ever speak to here is going to have a trade too large to exit from a large cap with a respectable pricing structure. Small caps could happen, right? They have lower liquidity. If you are stuck in small cap stocks and don't want to heed my advice and get out of them, it's fine. They're a reasonable thing to trade.

Understand that you have got to be careful about size versus liquidity. Large caps have a larger impact on the indices themselves. For example, if a stock like Apple has a disgraceful earnings report, they can affect the entire market. Small caps are the boat that the high tide rises and the low tide drops.

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