Examining Market Capitalization with Daily Stock Charts - dummies

Examining Market Capitalization with Daily Stock Charts

By Greg Schnell, Lita Epstein

Daily stock charts are a useful tool. You can calculate a company’s market capitalization by multiplying the total number of shares by the current price per share, which is called market cap in most financial reporting. Companies are typically compared based on their market cap. While there is no standard or minimum/maximum in the industry, a few companies that create market indexes have created some rough measures that change over time.

Rough rules of thumb are as follows:

  • Large-cap: Greater than $10 billion
  • Small-cap: Typically less than $2 billion

Larger companies have more institutional ownership by pension funds and exchange-traded funds (ETFs), so their stock behaves differently than that of small companies. Small-cap companies can regularly bounce and fall 5 percent a day, whereas large companies don’t have as many of those major swings. New investors would be well advised to resist the temptation to invest in small-cap stocks until they understand the wild price swings associated with these stocks.

When an individual investor has a portfolio of large-cap stocks, the portfolio behaves similarly to the market index. A market index is designed by a company placing a group of stocks bundled together to get an idea of the total price action of the companies within the index. The S&P 500 ($SPX) is a market index of the top 500 large-cap U.S. companies. The Dow Jones Industrial Average ($INDU) is another.

Because markets around the world are different and the United States has the largest market capitalization in the world, these large-cap groups are different sizes depending on the market you trade. Indexes for large-cap stocks are set up around the globe. Some of the most popular to watch include the following:

  • United States: S&P 500
  • Canada: TSX 60
  • London: FTSE 100
  • Australia: ASX 100
  • India: The Nifty Fifty

These indexes represent the most stable companies. A portfolio of large-cap stocks with diversification across business sectors typically mimics the movement of these indexes.

Some companies have dominant market capitalization. For example, Apple Inc. (AAPL) had a market capitalization in 2017 of over $700 billion. websites like Google Finance or Yahoo Finance will quickly tell you the real-time market capitalization of a company.

Daily charts look different depending on the company’s market capitalization. Liquidity, the ability to get in and out of the market fast, also is impacted by a stock’s capitalization.

Large-cap and high liquidity

Apple Inc. trades around 20 million to 30 million shares a day at $130/share. That means more than $2.6 billion moves every day in Apple shares. With that huge trading volume, the price moves smoothly by pennies each way throughout the day for the most part. Stocks that have high trading volumes are considered highly liquid. This liquidity is very important for large funds when they want to increase or reduce the size of their position by thousands of shares. The shares can still move up or down a lot in a day, but there are active buyers and sellers willing to own or sell at every penny move in each direction. This makes the stock more stable.

This chart has the volume traded per day shown on the bottom of the daily chart. The higher the bar is at the bottom, the greater the volume.

high liquidity stock charts
Chart courtesy of StockCharts.com
High liquidity share volume.

Small-cap and low liquidity

If you pick a small-cap company like Handy and Harman (HNH), you see that it broke out to a new high in 2017. HNH trades an average of 17,000 shares a day. It is very difficult for an institution to accumulate enough shares to influence its large portfolio positively. Conversely, when it wants to sell the stock, there are very few buyers for the number of shares it wants to sell.

low liquidity stock charts
Chart courtesy of StockCharts.com
Low liquidity share volume.

While the price of the stock may move to new one-year highs, it is not nearly as liquid as Apple Inc. Large-cap, liquid stocks get large institutional investors buying large positions when they break to new highs. This is rarely true for small-cap companies.

The image above shows the daily chart for Handy and Harman with relatively big volume as it moves to new highs, but the actual number of shares is still very small. For the first half of the month of May 2017, the stock traded less than 10,000 shares with no price movement for weeks. In February, it moved from a January 31 intraday high of $29.85 to $21.90. While the stock was dropping about 30 percent in three weeks, there was little to no buying interest.

This is the trademark of no liquidity. You are stuck holding the stock while it plummets. Handy and Harman may be a great company as it is breaking out to new highs later in the year. However, it will be hard to make money on the stock due to the lack of liquidity when you want to sell. If you can own a percentage of the daily float easily, it is probably worth avoiding. This is the type of stock a friend gives you a tip to buy. All stocks are easy to buy; they are harder to sell when you want to.

Charts with low volume are notoriously hard to make money on because someone has to buy the shares from you in order for you to profit. Speaking from experience, this is not where the big money is made in the market, but it can be lost there.