Q. Dear Josh, why is it more risky trading in stocks with low market capitalisations than large caps?
A. It’s all down to underlying liquidity and this means that one has the ability to get in, but more importantly, out of the market with ease and at a good price. The more liquid a stock, the greater the number of buyers and sellers for the shares and therefore the easier it is for one to buy a certain amount of shares at a certain price.
But when shares are illiquid there are very few shares switching hands so it can become much more difficult. Let’s say one wanted to buy £20 per point of Company ABC at the current market price of 180p, which is the same as 2,000 shares. But since the stock is illiquid, there are only 1,000 shares available at 180p and another 1,000 shares available at 182p. This means that you have to buy the equivalent amount at a volume-weighted price of 181p, which is more expensive.
With very illiquid stocks, the volume-weighted price of a transaction can sometimes be much worse and the same could apply to when you want to sell. There may even be a time where there are no buyers or sellers, meaning you can’t get in to or out of a market.
Q. Dear Josh, is spread betting for long-term traders?
A. There are contracts that you can spread bet on if you have a long-term time horizon. But the majority of traders use spread betting predominantly for short to medium-term trading as spreads are much tighter for shorter-term contracts. The time that spread bets are typically open for range from a minute by minute basis to a quarterly basis. Certainly at City Index very few are left open for longer than six months.
Q. Dear Josh, why is China important for the FTSE 100?
A. China is the world’s fastest growing economy and therefore plays an influential role in stock exchanges around the world. It can have a more influential role because there are several heavyweight mining stocks on the FTSE 100. Many of these mining companies rely heavily on demand from China for basic resources. So when China tries to cool rapidly rising inflation through monetary tightening, it can have a big effect on metal demand and on the miners themselves.
You can learn more about the markets and spread betting with Josh at his free City Index seminars.