Volatile price swings seem to be the name of the game in the small-cap world these days – and after hitting record-breaking volatility back in December, many investors have been left wondering when things are going to calm down. But unlike blue-chip stocks, where high price volatility is an unwelcome trend, that same price flux can equal serious profits for small-cap stocks.

Keep this volatility tip in mind and you’ll be well on your way to profiting from the price swings…

It can be nerve-racking to watch a stock pinball. And if you own shares of any penny stock, you have to be able to spot whether or not the stock is taking a turn for the worse. But wild price swings don’t always mean that there’s cause for concern in your small-cap portfolio.

OTC Is Inherently Volatile

Volatility is inherent in any small-cap stock, but that’s especially true of stocks that trade over-the-counter, or OTC.

And now, with volatility higher than ever on the big boards – like the NYSE and the NASDAQ – as well, the volatility we’re seeing in the penny stock arena is unprecedented. That’s why we need to consider the cause of the volatility, because the reason for a price swing can often tell us quite a bit about where prices are headed next.

First, you need to look at the bid and ask.

The bid – the price that investors are willing to pay for shares – and the ask – the price shareholders are willing to sell shares for – are key parts of how shares of a stock are priced. With blue chips, the difference between the bid and ask price (known as the spread) is tiny, but for penny stocks spreads can be enormous.

Just look at WordGate Communications (OTC: WGAT), which has a 4 cent spread as of Friday morning. With WGAT currently trading at $1.04 per share, that spread represents almost a 4% of the company’s share price – and many OTC stocks have much higher spreads.

That’s largely a product of volume, which is the number of shares that trade hands during trading. Because investors set the market prices of stocks by their buying and selling activity, all any stock needs to make a serious move (up or down) is trading volume. That’s why it’s exciting to find a stock that can make a big move without a lot of extra buying power behind it.

You may have heard a broker or trader talk about a stock that “moves on air.” Simply put, it doesn’t take a lot of extra buying to get shares to blast off. That’s why traders are always looking for “low floaters.” These are the stocks that don’t have a lot of shares that are unrestricted and available for trading on any given day. That’s often true of penny stocks – with relatively low trading volume on any given day, small share transactions can be a major component of share price.

That’s why OTC stocks are so powerful. Little bumps in volume can translate into huge moves in the share price. That was certainly the case with WGAT – shares have rallied 134% in the last month alone thanks to a volume-induced push. And other OTC plays, like IMAGING3 Inc. (OTC: IMGG) have fared even better, pushing 1,580% in the last thirty days.

That’s performance that you’ll only find with bulletin board stocks…

When investor interest returns and volume picks up — thanks to positive news, earnings or guidance — the spread should shrink and the stock should move up nicely.

Just look at the real-time streaming quote generator on your online brokerage site. Type in your favorite blue chip and you’ll see a flurry of activity. Thousands upon thousands of shares will trade in a matter of seconds right before your eyes.

Now type in WGAT or IMGG – two OTC stocks that we’ve been getting quite a bit of reader mail about recently. If it’s a busy day, you could see the bid or ask tick up and down a bit, with a few thousand shares exchanging hands over the course of the morning. But then there are the slow days, when the stock barely moves at all…with a painfully large spread.

That’s nothing to worry about. Just remember this: If there’s no unusual volume backing up a drop, chances are the move won’t hold. Sometimes you’ll see a “shake” — the stock price taking a dive on the sale of just a few hundred shares. Don’t fall into this trap and sell…prices will more than likely return to previous levels sooner, rather than later.

Cheers,
Jonas Elmerraji

Source: Why Volatility Equals Profits for Small-Cap Stocks