Welcome to The Ultimate Guide to Small Cap Stock Picks:
Thank you for visiting! This 3,500+ word detailed guide will help you get started picking small cap stocks. Whether you are brand new, or looking for a quick refresher, this small cap stock guide has everything you need.
This in-depth guide contains all the information you need: from where to find breakout ideas, to tips on risk management. So keep reading!
Because as you probably know, small cap stock picking presents a ton of potential profit. And by reading this guide you’ll be well on your way to this kind of success.
But in case you’re wondering…
Why Should You Invest in Small Cap Stocks?
It’s like that old saying goes… good things come in small packages.
Of course, you might not have expected that to include the stock market. But in the case of small capitalization stocks, it DEFINITELY applies.
Except you still might be wondering…
Why do small cap stocks present such a BIG opportunity for traders and investors?
It’s actually quite simple.
You see since these companies are smaller, then by definition, they have more room to grow. But don’t take my word for it.
First Wiltshire Securities Management, specialists in small cap stock investing, also assert these smaller companies have higher growth potential.
And naturally, this growth potential can be extremely profitable for individual investors and traders… IF… you know what you’re doing.
I’ve had some great success with small cap stocks. In the last 8 months I’ve had one small cap stock deliver triple-digit returns (see below!) And other ideas have knocked it out of the park too…
On the other hand, small cap stock picking can also be VERY risky. That’s because these are often unproven companies, which might not even be turning a profit.
PLUS, there are some other unique factors to be careful of when buying small cap stocks (…more on that in a minute).
So what should you expect from this detailed guide?
Well… whether your preferred holding period is days, months or years, this guide will help you make smarter trading decisions when it comes to finding small cap stocks.
And by the time you’re done reading, you’ll know some of the MOST important frameworks for evaluating potential trade ideas in smaller market cap stocks.
But I won’t stop there.
I’ll also give you a link to the SPECIFIC stock screen I use to find the best small cap stock picks in the midst of breaking out.
This will help you take action on the information I’m sharing with you. (As long as you manage risk, that’s where the money’s made!)
With these easy-to-use tools (which you won’t find anywhere else), you’ll be able to start finding your own potential small cap investments.
Introduction to Small Cap Stock Picking:
I hope you’re starting to appreciate the AWESOME opportunity that comes with small cap stock picking.
If you know what you’re doing, (and with a little luck), you can find some BIG potential investment opportunities. Forget the stodgy mega-cap stocks of the Dow Jones and S&P-500!
Our hunting ground is the domestically-focused Russell 2000 index. It’s where small cap stocks are just waiting to be discovered.
Now don’t get me wrong…
I like a blue-chip-dividend-paying issue as much as the next guy.
BUT… you know what?
If you want to add a little more upside potential to your portfolio… well… I think small cap stocks are one of the BEST ways to do it.
And as Cabot Wealth reports, since Donald Trump won the 2016 presidential election, small cap stocks have been soaring!
So how can you find these alluring stock picks for yourself?
To answer it…
Let me show you the exact online investing tools I use to zero-in on these potential nuggets of small cap gold.
Keep reading, it’s easier than you think.
Strategies For How To Find Small Cap Stock Picks
When it comes to small cap stock picking, you should know most trades are NOT going to knock it out of the park.
A lot of these stocks will fizzle before the breakout has even started! Ouch.
But don’t lose hope.
Every once in awhile, you’ll find a huge winner that pays for itself… AND, pays for many other losing trades.
So in a nutshell:
This REALITY of the markets… (lots of small losers, fewer bigger winners)… should be reflected in your small cap stock picking strategy. That means you place lots of bets, and then manage risk with careful position sizing and disciplined stop-losses.
“The winners will take care of themselves…. and YOU!”
But you MUST keep losses small. So with this strategic approach as a foundation, let me show you where I find small cap trade ideas.
My favourite place to go when looking for small cap stock picks is FinViz.com. In fact,I’ve written before about how to use FinViz to find breakout stocks.
Let me show you how to adjust our focus to find the best up-and-coming companies.
Stock Screening for Small Cap Picks:
As you read this article, I encourage you to go over to FinViz.com and follow along.
Just click on the screener tab, which you can easily access from the home page:
This will take you to the default “description” screen and it lets you filter stocks based on a variety of attributes.
Depending on your preferences, you can focus on stocks in a single country, those getting upgraded by analysts, or even stocks trading below a certain price (like $5 or $10).
So how do I use this screen?
First and foremost, this is where you can isolate small cap stocks (as well as micro cap and nano cap stocks)!
Just click on the “Market Capitalization” field. Then you can see a drop-down menu where you can easily pick the size of company you are looking for. FinViz defines small cap as under $2 billion dollars.
Here’s a screenshot:
Personally, I would recommend picking small cap stocks and anything below as shown above…although you may decide you want to avoid stocks with market caps below $100M, but that’s really up to you. I like to cast a wide net and refine later.
Other than the market cap, I don’t like to get TOO picky about the descriptive filters.
As you can see above though, there is one more important metric I always adjust for.
Liquidity: a lot of small cap stocks don’t trade much. And this can make it difficult or costly to enter and exit your investment position. Therefore, I always adjust the “average volume” field to be 100k or greater. This helps narrow my universe to investments that are more liquid and should be easy to sell without too much of a bid-ask spread.
As I mentioned though, you can use the description screen to tailor your opportunity set.
If you’re looking for growth stocks you could eliminate companies that pay a dividend. This way, you’re more likely to invest in management teams that are reinvesting earnings into their business rather than distributing cash to shareholders. Make sense?
I encourage you to get creative and think about what descriptive factors can help you find the right securities for you to invest or trade in.
Here’s another idea:
Depending on your investing style, you may also choose to eliminate ETFs from your stock screen. This saves you time by only showing you opportunities for individual companies.
Another twist might be focusing exclusively on a specific sector.
For example, maybe you think the price of oil has bottomed so you want to speculate on some small energy names. The FinViz description tab lets you do that.
In fact, you could even go a step further and drill down to the exact industry, like oil services companies.
It’s truly amazing how much great information we have right at our fingertips!
You just have to put it to work!
So I encourage you to look at the description screen closely. It’s very helpful because it can be used to fine-tune your stock screen to help you find the EXACT opportunities you want.
Next, let’s move to the fundamental screen.
And don’t worry… it’s SUPER easy!
To get started:
Just hit the “Fundamental” tab on the screener page to see a bunch of new criteria we can use to find the best small cap investing opportunities.
Fundamental Considerations for Picking Small Cap Stocks:
Now, a lot of trades don’t care about fundamental analysis. But I think this is a mistake.
I strongly believe… (based on my personal experience) that traders can use some basic fundamentals to GREATLY improve their odds of success.
“So what fundamentals should you look for in a potential small-cap investment?“
Well, there are tons of different ratios and valuation metrics you can consider. So I’ll show you what I like to focus on.
You can use that as a starting point to start build out your own criteria. Sound good?
Then let’s get down to business.
So first things first: I always like to avoid companies with lots of debt. Why?
Because I’m most interested in companies that are able to finance growth with cash from operations. This makes it less likely they will be beholden to their bankers when times get tough.
It also makes it less likely you will wake up to a surprise dilution or debt issue. And I think this factor is ESPECIALLY important when it comes small cap stocks though.
Do you know why?
It’s because unlike a Fortune 500 company, many smaller stocks will have higher borrowing costs than the likes of Google or Apple.
Because these smaller companies are less well-established, having space on the balance sheet is another margin of safety if they run into operational challenges or execution troubles as they scale.
When looking at the fundamental screen, I only include companies with a debt/equity ratio below 1.
The next fundamental number I like to look at is return-on-equity (ROE). That’s because ROE helps to illustrate how profitable a company is for shareholders.
For example: If a stock has had an ROE of 20%+ for the last 10 years, it’s likely a highly profitable business with a VERY strong competitive advantage.
That’s the kind of company I want in my portfolio! So on the fundamental tab I usually eliminate companies with ROE below 15%.
And by the way…
One key thing to note is that companies with a lot of debt can actually inflate their ROE numbers. That means if you’re not careful, GAAP accounting principles can distort the data in your stock screen. The Blue Collar Investor has a great discussion on these accounting intricacies for stock screeners.
So that’s another reason I like to avoid over-indebted companies. Make sense?
Of course, if you’re curious for more information on the relationship between debt and ROE you may want to read about DuPont Analysis.
Now… as I said… those are the most important criteria for me personally. But you don’t have to stop there!
No sir, this is just the tip of the iceberg.
To keep you going: Here are some more ideas to help you get exactly the kind of small cap trade ideas you want:
- Value: you can focus on cheaper stocks by screening for price-to-earnings, price-to-cash flow and/or price-to-book to find companies that the market is giving away on sale.
- Growth: consider looking at the future sales or EPS growth expectations. FinViz lets you filter by 1 year and 5 year projections. So if you only want to focus on fast growing companies, this can be a great way to do it. This is especially important for finding explosive small-cap opportunities.
- Profitable: some investors (myself included!) prefer to focus on companies that are making money for shareholders. By looking for companies with positive operating income and/or EPS you can stay centred on businesses that are making money.
The point is, there are many ways you can screen for fundamentals. Personally, at this point I prefer to just keep it simple by eliminating low-ROE and high debt companies only.
But take some time for yourself and play around with this. Experiment with how different filters change the output.
I remember when I was just starting out with stock investing, I used to spend HOURS each evening exploring different fundamental stock screeners.
It’s fun to see what comes out based on what levers you pull. And we haven’t even talked about technical analysis yet!
Small Cap Trend Following with Technical Analysis:
One of the best parts about FinViz is how you can make hybrid stock screens with both technical AND fundamental filters.
So… while you’re now up to speed on the fundamentals… the technical analysis piece is where the rubber really meets the road.
Because I always use technical analysis to plan my specific spots for buying and selling.
Because while fundamental analysis is a great way to find high quality companies, it doesn’t tell you how to trade the stock or manage risk.
And remember, I’m a guy that used to invest exclusively based on fundamentals. So…
I am NOT against value investing. It’s just been my experience that layering on some basic technical rules can really help your performance and reduce risk. This paper, Foundations of Factor Investing from MSCI, also makes the point that momentum signals (amongst others) can augment returns.
So let me show you how that works right now.
And in case it’s not clear: The first thing you need to know is that as a trend follower, I’m buying breakouts.
It’s not about waiting for reversion to the mean. I don’t use profit targets or predict where a stock will go. I simply look for the trend using the technical fields in FinViz, and then align myself with it.
How to Find Breakouts on FinViz with Technical Analysis:
So how do you find the trend? Great question.
The technical tab on FinViz has everything you need!
Specifically: One of the easiest and most objective ways to find stocks in strong uptrends is to look at moving averages.
And do you know what I REALLY like to see?
Since I only trade on the long side, I love to see stocks that have upward-sloping and smoothly aligned moving averages!
Here’s an example of what I look for:
Do you see how this works?
The moving averages help smooth out the day-to-day fluctuations of the stock.
And when the 25-day, 50-day and 200-day moving averages are all sloping in the same direction (as shown above), then this is indicative of a strong trend.
For more information on this topic, you can read more tips for trend following with moving averages .
But the main point is…
I use the slope of the moving averages to identify the direction of the trend.
And unlike many new traders:
I don’t worry too much about whether or not price temporarily dips below a moving average.
So with that theory in mind…
Here’s exactly how I would look for a trend using the FinViz technical screen:
Now, with those criteria in place you can start to easily find stocks in uptrends.
And by the way:
If you wanted to short stocks in downtrends, you could simply do the opposite and look for down-sloping moving averages.
Good.Now let’s go one step further.
Because I don’t want to JUST buy good stocks in uptrends.
I want to focus on stocks that are breaking out RIGHT NOW. If you strike when the irons hot, you have the best chance of being immediately profitable.
Well… let me put it this way…
A financial security in motion tends to stay in motion!
The momentum effect is a real thing, and Quantpedia has a great article explaining why this is. and while buying breakouts can be uncomfortable, it can also be VERY profitable!
That’s why I always include a technical filter for new 50-day or 52-week highs.
And while that might sound obvious… success in the stock market is much easier IF… you buy what other people are buying!
Buying stocks at new highs is the easiest way to do this. Just remember to plan your exit before you enter!
Next, keep reading to learn how you can put these ideas into action with a single mouse click.
An Easy-to-Use Screen for Finding Small Cap Trade Ideas:
I know we’ve covered a lot of ground so far. AND…
I want to reward you for sticking with me!
So while you can certainly reconstruct the stock screen I’ve described, I wanted to save you some time.
That’s why I went ahead and pre-created this FinViz screen for you:
And best of all, if you hit the “charts” tab on your stock screen, you will get all your results in an easy visual format.
I LOVE this approach because it’s so intuitive and makes scanning the results super quick and easy.
Now… before we wrap this up…. there are just a few extra factors you might want to be aware of.
Unique Factors to Keep in Mind When Trading Small Cap Stocks:
While the stock screen I linked above is more than enough to get you started, I still wanted to go a step further.
When you’re trading small cap stocks, there are some special considerations you might want to keep top of mind.
In no particular order, here are some of things I want to tell you about:
Insider buying and selling
- In the world of small cap stock investing, the activity of insiders can get a lot of attention. Consider updating the description in your FinViz screen to eliminate stocks where management is selling; or, to find companies in which executives are gobbling up shares.
Above average volume
- Since small cap trading volumes are usually subdued, it can pay to keep an eye out for above average trading volume. This is easy to screen for with FinViz using the relative volume field on the descriptive tab. It could help you find big winners before they take off, or avoid potential losers that are being unloaded.
Percentage of shares sold short
(and size of float)
- In my experience, the number of shares outstanding can make a big difference on price action. Stocks with a small float (number of shares outstanding) can move much faster than their larger brethren. This effect can be amplified even further if a large percentage of shares are sold short. I highly recommend reading How to Trade in Stocks by William O’Neill for more details on why a small float can lead to fast market moves.
While these nuances aren’t essential, if you can gain a strong understanding of these topics you will have an even stronger handle on how to trade small cap stocks.
There’s just one more thing we need to cover…
… and given how important this last part is, you don’t want to miss it…
Risks to Investing in Small Cap Stocks:
Before we finally finish this in-depth guide on small cap investing, I just want to cover some of the risks.
Using the stock screen above, we’ve already done our best to avoid companies with high-debt and unprofitable operations. And this is important because, personally, I think those are some of the biggest risks to buying small cap stocks.
The other critical concept to keep in mind is the importance of using a stop-loss and defining your risk before you enter a trade. While this approach is always recommended, it’s especially important for fast-moving small-cap stocks…
If you aren’t careful about planning your trade BEFORE you enter, you can be staring at a MASSIVE loss before you know it.
For more on this vitally important concept please read more about how to plan for losing trades.
Finally, while the instructions above give you detailed steps you can follow to pick your own small cap trade ideas, I wouldn’t stop there.
More Great Resources For Finding Small Cap Stocks:
There are some great resources out there to help you get started finding small cap and micro cap stocks. While I personally don’t trade in penny stocks, there’s lots of information about it on the internet.
So, if you’re still hungry for more small-cap stock pick resources or information, check out some of these providers:
MicroCap Research regularly publishes articles with small and micro cap stock ideas.
Small Cap Informer publishes small cap stock picks with large growth potential.
Small Cap Power is another place to find top news stories for small cap stocks.
Next Small Cap Stock regularly publishes articles with new small cap stock ideas.
SmallCapTraders.com is a community offering small cap stock picks and alerts for free.
Australia’s Money Morning has a great guide to finding small cap stocks and a lot of the country-specific lessons can be applied globally.
QualityStocks.net offers a variety of small cap and penny stock trading services.
StockMyMoney.com shares 3 small cap stock picks for 2017.
WiseDollar.org has also published a great list of 5 small cap stocks you’ll want to watch this year.
Finally, InvestorPlace.com published 10 small cap stocks that could double in 2017, which you won’t want to miss.
A Trading Checklist to Help You Succeed:
Before buying any stock, I ALWAYS run it through my proprietary stock buying checklist. Why?
Because this helps me spot any red flags BEFORE I put my money at risk.
I also pick my position size (number of shares to buy) and stop-loss levels, prior to placing a buy order. This way, I always have a plan for when to sell my stocks. And I always know my max loss ahead of time.
Good. Because trading and investing in small market cap stocks can be fun and profitable. Just remember to do your own due diligence.
I Can Help:
So to help speed that up, you may want to consider downloading my small-cap stock investing checklist. It will give you a concise and succinct summary of everything in this article. To request your free copy, you can fill out the form below or email [email protected] and I will personally email you a complimentary copy. Would you like yours?