Small Cap ETF | Exchange Traded Funds

A small cap ETF is an exchange traded fund that is comprised of stocks with a small market cap size. Its a way of investing and trading in groups of small companies without having to go through and do stock picking all day long.

Using small cap ETF products combine the unique market behavior of small stocks with the ability to trade entire sectors of them in one shot. These instruments are relatively new and there are strategic ways to trade them if you know some of their characteristics.

These are just a few of the components and angles that you can use a small cap ETF to leverage when trading in the stock market. These are the moving parts and these are some of the ways they all fit together in the big picture.  These ETF's may be some of the best investments for those looking for fast growth and an easy to manage security.

Exchange traded funds are baskets of stocks that are sold just like any other share of stock on the major exchanges. In a small cap ETF, it would be a basket of only small companies with a market cap of generally less than $2 billion.

Trading in ETF's has become an increasingly popular alternative to investing in mutual funds. It is a very cheap and easy way of investing in entire sectors, in this case small cap stocks, without having to screen and pick individual stocks. Someone else does the stock screening for you.

ETF's are similar to mutual funds in that they are groups of stocks. Sometimes they track a particular index, like the S&P 500 or DJIA. Sometimes they are hand picked by some fund manager at an asset management firm.

More and more investment firms have begun to offer an ETF that mimics other index funds and actively managed funds they offer. This is due to the shear demand for them by modern investors.

There are two main benefits to buying and selling ETF's. First of all, they are cheap. Most mutual funds have expense ratios and management fees that can exceed 1-2% of the value of the fund. That can get to be a very expense premium to buy into some of these funds.

ETF's by contrast has no management fees. Instead you would pay your stock broker or online brokerage your usual trading commission to buy and sell ETF's.

Small Cap Advantages

Small cap stocks have unique characteristics that traders and investors have been taking advantage of for a long time. Using a small cap ETF just takes that to another level.

These stocks are generally attractive because of their growth potential and in some cases with swing traders, for their volatility. Let's talk about the growth potential first.

It's a simple concept. Big companies have less room to grow. If you buy shares in GE which has a market cap of about $192 billion, it will be a lot harder for you to double your money than if you were in a small company that could eventually become a large cap like GE one day.

The big idea in investing in small caps is that you are looking for the next Google or Microsoft and buying share in that company before they become that. You may also be looking for small companies that have the potential to be swallowed up by a bigger company through acquisitions, which happens all the time.

For swing traders or day traders, small caps offer the volatility they need to quickly buy lows and sell highs. It also offers the big swings that enable them to get big gains, enough to at least cover their commission expenses.

The ETF Advantage

There are several reasons investing and trading in a small cap ETF is advantageous. Here they are in brief.

Liquidity - One of the problems of trading in individual small cap stocks is that they are sometimes not liquid. That means when the share price is where you want it doesn't always guarantee that you will have readily available and willing buyers or sellers you need to make a trade. That can be a huge problem especially if you need to exit a trading position.  There are ETF's that don't have great liquidity, but they are generally more liquid than individual stocks.

Diversification of Risk - One of the nice things about ETF's is that you don't have to individual stock screen every stock. There are some ETF's that follow an index of thousands of small cap companies, like the Russell 2000 index for example. This means that rarely a single stock tanking will make a huge difference in your portfolio or trading strategy. You can trade on the unique characteristics of the small cap as a whole sector without getting distracted by a stock or two that doesn't follow the pack.

Scam Prevention - A potential problem anytime you invest in a small company is the possibility that it might be a scam company or shadow stock, like the one you saw in that movie The Boiler Room. Many of these small cap indices analyze and screen the stocks for this kind of possibility.

The contents of this page are solely the opinion of the author. Expert financial advice should be sought before any money is invested or traded in any kind of security. This is not an offer, recommendation, or solicitation in any of the securities, funds, ETF's or strategies mentioned in this hub.  By reading this, the reader understands that the author is not liable for any losses that may incur.  The strategies and analysis in this hub is based on historical performance and may change and fluctuate due to market conditions.