In the stock market, there are many kinds of companies that offer their shares to investors. We study how these companies operate and how their shares perform. But it’s really important to focus on small cap and mid cap companies too. These companies can be riskier, which doesn’t necessarily mean they’re bad, just different. We’ll talk about this in more detail below.

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Now, let’s address the question: What exactly are small cap and mid cap companies? We’ve touched on this in previous articles, but let’s quickly recap. Small cap companies have their own market value ranging from 1,000 crore to 5,000 crore. On the other hand, mid cap companies have market values from 5,000 crore up to 25,000 crores. These companies not only have fewer shares available, but they also tend to operate on a smaller scale, with fewer plants, cash, assets, and customers. However, what’s particularly interesting is the concept of “less stocks free floating in the market,” and that’s what we’ll delve into next.

When a company decides to join the stock market and offer some of its stocks to the public, those available shares are called “free floating stocks.” Let’s say a company has 1,000 of these stocks, and each is initially priced at 10 rupees. This would make the company’s market capitalization 10,000 rupees (1,000 stocks x 10 rupees per stock). Now, fast forward a few years, and let’s imagine the company’s stock price has increased to 50 rupees per share. This would boost the company’s market capitalization to 25,000 rupees (1,000 stocks x 50 rupees per stock). Now, here’s where things get interesting. Sometimes, a company might decide to reward its shareholders by offering them bonus shares. This means the company would increase the total number of its stocks, and as a result, the price of each individual stock might adjust. But don’t worry, the total value of the company – its market capitalization – would likely remain around the same, even though the stock price and quantity change. This can be an exciting move for the company and its shareholders, potentially causing the stock price to rise further, and consequently, increasing the company’s overall market capitalization.

Returning to the key question of how these companies might carry an element of risk, the answer hinges on a few critical factors. The foremost consideration is the composition of the company’s shares. Typically, around 75% of the shares are held by the company’s founders and promoters, leaving only a modest 25% available for trading on the market. Within this smaller pool of tradeable shares, prominent investment institutions, high-net-worth individuals (HNIs), and domestic institutional investors (DIIs) also secure a significant share. Additionally, major investors, influential market players, and mutual funds often acquire substantial stakes. This scenario leaves a limited quantity of shares available to retail traders and individual investors.

What accentuates the potential for rapid price fluctuations is the relatively low volume of shares being actively traded in the market. Even a modest amount of trading activity can swiftly propel prices upwards, as evidenced by instances where mid cap and small cap stocks register substantial daily gains of up to 10%. In fact, it’s not uncommon for small cap stocks to frequently hit upper circuits, wherein trading is temporarily halted due to overwhelming demand. This phenomenon contributes to the swift generation of substantial returns over notably short periods, making small cap and mid cap investments capable of yielding remarkable profits at an accelerated pace.

However, on the flip side, the dynamics of small cap and mid cap companies can also entail a certain degree of vulnerability. When significant traders, high-net-worth individuals (HNIs), and domestic institutional investors (DIIs) decide to sell off their holdings in response to various factors such as news developments or profit-taking, an influx of supply floods the market with the company’s stocks. This surplus of available stocks can trigger a rapid and pronounced decline in stock prices. Given the relatively limited quantity of shares held by the company, the large-scale influx of stocks into the market can swiftly lead to substantial declines, fostering an atmosphere of panic selling among both retail and individual investors. This scenario is often amplified by the fact that small cap stocks are more prone to steep drops, frequently experiencing declines of 40% to 50% or more. When retail investors observe such a dramatic downturn, their confidence in the potential for recovery diminishes, further contributing to the prevailing sense of market turmoil and uncertainty.

Risky moments are not necessarily bad; they’re a natural part of mid and small-cap companies. On the flip side, large-cap companies have a vast number of freely tradable stocks, making it challenging to manipulate their prices based on supply and demand. Large-cap firms have already demonstrated their performance, so when their stocks dip, savvy investors and traders see an opportunity to pick up shares, leading to a rebound in stock prices. News and profit-taking typically don’t heavily impact large-cap stocks, unlike their smaller counterparts. Small and mid-cap companies also possess fewer assets, such as manufacturing plants. If one of these plants is disrupted by a natural disaster, it affects production and shows up in their quarterly results. This isn’t as much of a concern for large-cap companies, as they have the advantage of a greater market share for their products. While small and mid-caps face more competition, large-cap companies encounter less. Additionally, news tends to have a more pronounced effect on mid and small-cap stocks compared to large-cap stocks.

Disclaimer: The content provided in this article is intended solely for educational and informational purposes. We do not offer any recommendations or solicitations for buying or selling securities, nor do we endorse any specific trading strategies or investment decisions. The information presented here does not constitute financial advice or a call to action in the stock market. Before making any investment or trading decisions, readers are strongly advised to conduct thorough research and analysis of the relevant companies, including their financial statements, performance metrics, and market trends. It is important to carefully consider the risks and potential rewards associated with investing or trading in the financial markets. Furthermore, readers are encouraged to consult with a qualified financial advisor or professional before making any investment decisions. The decision to invest or trade in the market should be based on careful consideration of individual financial circumstances, risk tolerance, and investment objectives. We do not assume any responsibility or liability for any losses, damages, or consequences that may arise from the use of the information provided in this article. All readers are advised to exercise due diligence and make informed decisions when engaging in any financial activities.

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