Overview of Small-Cap Stocks

Small Capitalization Stocks are stocks that contribute to no more than $1 billion dollars of a company's equity. The value of a company's capitalization is commonly calculated by multiplying the number of a company's outstanding shares by it's share price or average share price. There are also micro-capitalization stocks that have even lower amounts of equity capitalization, but this article will focus on Small cap stocks. A few of the general features of small cap companies are as follows:

• Smaller share prices on market exchanges
• Subject to higher risk from larger competitors
• Greater growth potential
• Potential stock price volatility

Benefits and risks

Each capitalization class of stocks have certain advantages and disadvantages associated with them. Some tend to be higher risk whereas others tend to be lower risk. These benefits and risk also vary depending on the economic sector in which stock trading occurs. An overview of the benefits and risks associated with small cap stocks is provided below:

• Benefits of Investing in Small Cap Stocks:

 Small cap stocks are cheaper to buy than mid cap and large cap stocks. What's more, small cap stocks under $5.00 per share are not as well studied by financial analysts. This can be an advantage as a company may be undervalued due to this media deficit. Also, since these stocks represent smaller companies, there is more potential for earnings to grow at a larger percent than a well established company with strong market positioning. Since these companies are smaller, they may also be acquisition targets for larger companies which is often good for a stock price.

• Risks

Since small cap stocks are cheaper to buy, one can buy more of them. What's more at a lower cost per share, any decline in value is a proportionally greater percentage loss of invested capital than with a higher priced stock. For example, if person A owns 100 shares of Berkshire Hathaway Class A shares and Person B owns 1000 shares of Little Cap's Are Us Corp. and Person A's shares cost $100K per share and Person B's shares cost $10 per share, person B is going to experience a far greater investment loss if his or her shares decline $1 than if Person A's shares decline $1.

Risk avoidance techniques

The risks associated with Small Cap stocks can be mitigated through investment strategies or trading tactics. In an investment strategy an investor may choose to diversify one's small cap investments by purchasing several small cap companies across several industries and/or purchasing a large cap competitor in the same industry. This reduces the risk of investment loss should one company go belly up in competition.

In terms of trading, long positions can be hedged with short positions and short positions can be hedged with put options. While risk mitigation reduces the potential for loss it may also inhibit potential gains. A few of the risk mitigation methods one may utilize when investing in small cap stocks are as follows:

• Diversify across multiple industries
• Select only small cap companies with proved financial strength
• Purchase mutual funds that specialize in small cap companies
• Avoid small caps altogether

Tips for investing in small cap stocks

Investing in Small Capitalization stocks is generally for investors and traders with at least some taste for risk. For this reason it is important to utilize a well thought out entry and possibly exit strategy. Below are some techniques to stabilizing an investment strategy:

Stop loss orders:

By not allowing stocks to decline by more than 10% investors are in effect risking no more than 10% of their capital per investment.

Emotional control:

Emotional investing is shunned by some professional investors. Emotions can cause one to sell a stock that is about to rocket or buy a stock that is about to tank. Using logic and exercising fiscal discipline helps one manage money unemotionally and can reduce risks associated with emotional investing.

Research:

Due diligence is a hallmark of fundamental stock analysis. If it's done right, it can probably reduce risk if accompanied by good decision making.

As with most investments, risk is always a factor that can only be minimized but not always eliminated. Many investors have experienced loss at one time or another. Even large brokerage firms, high powered investors and sophisticated investment computing algorithms are not completely immune to unexpected events in the World and economic markets. Nevertheless, investment in small capitalization stocks can be profitable and the potential for profitability may increase by utilizing the information in this article.

What is An Options Spread?

An options spread is a technique used in stock options trading that makes use of two financial instruments known as 'options' orders so as to hedge risk and increase probability of profit by making use of different price movements by writing, selling, and/or buying options. An options spread can be used with any underlying market that allows trading via options.

The name option spread is no coincidence as the option is literally an option to use a financial instrument for a price. A spread represents two price points such as in a bid/ask spread, only in options, the spread is between two prices. When the words 'option' and 'spread' are brought together, so are the meanings of each word i.e. two options that represent a trading technique that involves financial contracts.

How an option spread works

Options are a derivative financial instrument meaning their value is derived from an underlying product. For example, with stock options, shares of a company are packaged into groups of 100 and bought and sold for a contract price or premium. The options can be either in the money, at the money or out of the money. This means the price of the underlying financial instrument can be either profitable, not profitable or even when exercised or used.

This contract, if bought, allows buyer to 'exercise' the options at a certain price before a specific date. If sold, the buyer of the option pays a premium to the seller and the seller pays the buyer if the option is exercised 'in the money' or beyond the 'strike' price i.e. the price after which the option becomes profitable. Some of the key elements of an options spread are listed below:

• Order type: ex: Limit order, market order, stop loss
• Risk: Potential to lose money via the spread
• Market: ex. Bull, bear, secular, cyclical
• Strategy: Option spread(s) used
• Broker: Trade facilitator
• Product: Stocks, commodities, currency

Types of option spreads

The type of option spread used reflects the strategy of the spread. For example, a calendar spread makes use of two different expiration dates for the same type of option. This type of spread may be used when the buyer or seller is convinced of a price movement but not the time when the price movement will occur. A number of different spread types exist, some of which are listed below:

• Bull Call Spread: Hedges cost of bullish options
• Bull Put Spread: Premium benefit if stock remains above strike price
• Bear Call Spread: Benefits flat price movement
• Bear Put Spread: Inverse of Bull Call Spread
• Calendar Spread: Makes use of different option expirations
• Backspread: Lowers risk for up and down price movements

Each of the above mentioned spreads makes use of different option types, techniques and predicted price movements. The variable element is the price movement which is it not guaranteed, and the details of each spread involve several variables and concepts, only a few of which are mentioned herein. In other words, when researching and making use of option spreads, it can be a good idea to pay close attention to 1) how the spread works, 2) when it is profitable, 3) the likelihood of it succeeding and 4) the monetary risk involved.

Summary

An options spread is trading mechanism that makes use of two financial instruments known as options. These are comprised of products from which the options' price is derived. Different types of options spreads are used to make use of 1) different price movement directions, 2) time of price movement, 3) extent of price movement and 4) combination of options used.

Options spreads are bought and sold using brokers and trade through markets such as the Chicago Board Options Exchange (CBOE). Options spreads are regulated by the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC). These regulatory bodies are further assisted by the participation of individual options exchanges in collaborative surveillance of their business through the Options Regulatory Surveillance Authority (ORSA)

Source: http://www.optionseducation.org/ (Options Industry Council)

How to Determine the Cost Basis for Tax Exempt Funds

The cost basis of tax-exempted funds pertains to 1) earnings yields through mutual funds and/or retirement and/or insurance instruments that incur income from tax free investments, 2) Accumulation of earnings that are reinvested within a fund and 3) sale of funds that garner tax exempt dividend income. In other words, yield, ownership and capital gains of tax-exempt funds are subject to different taxation rules and cost basis calculation.

To illustrate what a tax-exempt fund is, the example of a mutual funds that itself invests tax-exempt financial instruments can be used. Such a fund may invest, trade or reinvest in a number of financial instruments that may yield earnings that are taxable, non-taxable or a combination of both. Such being the case, not all yields through tax-exempt funds may be tax free as this depends on the types of investments within the fund, the management of the assets within the fund, and local, state and federal laws.

Earnings from a tax-exempt fund that themselves are non-taxable and re-invested into the same fund do not increase cost basis but rather market value if the value of the fund stays the same, falls less than the value of the reinvested earnings or rises. This increase in market value is an unrealized capital gain and only become taxable following realization.

Furthermore, while earnings within a tax-exempt fund may be taxable, potential gains made from the sale of the fund are usually not. However, in the case of certain retirement and insurance products, capital gains may either be tax deferred or tax exempt due the tax protection provided within that retirement instrument.

Determining the cost basis for tax-exempt funds is a multi-tiered process involving 1) the determination of tax exemption and 2) the cost of those tax-exempt funds. And 3) the realization, un-realization or re-investment of income earned with a given tax year (www.investopedia.com).

Cost basis is a calculation that can be useful in a number of financial scenarios that may benefit an individual, tax payer or business depending on if the cost basis of an asset, investment, capital expenditure, income after cost etc. are favorably valued. A few of the areas in which cost basis can be beneficial in terms of tax exemption are as follows:

• Tax planning for individuals, businesses and non-profit businesses
• Investment valuation in deferred or non-taxable retirement instruments
• Bookkeeping of cost basis of transactional proceeds through non-taxable instruments
• Asset management and cash-flow cost determination
• Preparation of quarterly, annual, personal or business financial documents

Determining tax exemption status

There are several types of tax-exempt funds and financial instruments, some of which may have differing yields. The first step in determining cost basis of these funds is to clarify what, how and why certain funds are tax-exempt. The following list of tax-exempt financial instruments illustrate the various type and reasons for tax exemption.

• Tax-exempt mutual fund: Invests wholly or in part, in tax exempt financial instruments
• IRA or retirement plan that incurs income through a tax-exempt fund
• Hedge fund(s) that invests in tax-exempt funds
• Exchange traded funds with tax-exempt earnings
• Insurance policies with cash value from investment in tax-free instruments/funds

While tax exemption on earnings may be a good thing, they are not necessarily more cost effective than other funds if 1) the fees and charges associated with the funds management offset the tax savings and 2) other funds managed by the same company yield a higher after tax return for the same investment risk level.

Calculating cost basis

Cost basis can be calculated in terms of yield and capital investment. Applying cost-basis calculations to both can better determine the quality, value, and opportunity cost of the investment. The following illustrates cost basis calculations based on 1) taxable cost basis of yield, and 2) tax-exempt cost basis of investment.

• Taxable cost basis

Calculating the taxable cost basis of a tax-exempt fund yield cost basis can be determined by taking one's taxable income rate, for example 28% and then using that to determine the pre-tax yield if the fund where taxable (money.cnn.com) For example, Fund A yields an annual not taxable return of 2.88%.

If the earnings were to be taxed at 28% an equivalent taxable yield of 4% would be required to create the same 2.88% return i.e. 2.88%/1-.28=2.88/.72=4%. Alternatively, a funds that's earnings are taxable with a yield that is also 2.88% would have an after tax earnings lower than the tax exempt fund i.e. 2.88% * .28=.8064; 2.88%-.8064=2.07% actual return.

• Tax-exempt cost basis:

Since cost of an investment is also relevant for taxation matters, this original cost basis is also useful in addition to taxable and not-taxable cost basis of yield. Since market prices of tax-exempt funds can vary with fluctuations in market conditions such as bond price movements, interest rates, economic growth rates etc. actual values of funds can vary.

However, cost basis of tax-exempt funds is not based on market value hence the purchase price is usually used in determining cost basis (investopedia.com). There are of course exceptions to this rule of thumb, particularly in the case of reinvestment of capital gains and/or non-taxable dividends into taxable funds. Calculating the tax-exempt basis of such a fund is thus a simple matter of purchase price.

Cost basis adjustment on reapplication of income after unrealized reinvestment of earnings

In situations in which capital gains are realized after realized tax-exempt earnings of tax-exempt funds are reinvested in the same fund within the same or a following tax year, the cost basis of the reinvestment will reflect a higher amount. (investopedia.com) For example, on January 1, Mr. Jones buys 1000 shares of XYZ tax-exempt fund at a price of $27.50/share with a $25.00 commission. The funds are within a non-retirement investment account that consequently is subject to taxable earnings.

If the fund increases in market value by $1.00/share and incurs a non-taxable dividend income of .50 cents /share and Mr. Jones holds the fund until the following year in which he earns another $500.00 non taxable dividend income and a $1000.00 qualified end of year income redistribution. Since the non-taxable earnings were reapplied to the fund through income reinvestment, the cost basis of that investment rises to $27,500 +$2000=$29,500.00. Jones then sells 1071.42 shares (averaged reinvested dividend of 28.00/share) at $28.50 for a price of $30,535.71. Since the cost basis was adjusted up to $29,500 and the fund was held for longer than a year, the tax rate and total taxable income declines.

Summary

In summary, cost basis can be calculated on yield, investment and reinvested earnings. Calculating cost basis in terms of yield allow for financial comparison with similar taxable related investments. Moreover, cost basis varies with investment vehicle the tax-exempt is bought through, and the investment status of the fund i.e. original or reinvested capital. Since taxation of funds differ based on what tax free instruments are invested in, earnings on tax-exempt funds may be either partially or completely tax free.

Determining exactly how earnings will be taxable depends on the fund itself, the tax laws within one's state, tax bracket and investment strategy. Additionally, reinvestment of earnings and capital gains can lead to a higher overall cost basis that can be reflected in individual tax calculations. Such increases in cost basis of tax-exempt funds that also reinvest dividends and qualified distributions may consequently be beneficial to lowering taxable income within some tax planning strategies.

Sources:
1. http://www.investopedia.com/terms/c/costbasis.asp
2. http://www.fairmark.com/mutual/exempt.htm
3. http://money.cnn.com/2004/12/10/pf/expert/ask_expert/index.htm
4. http://www.ehow.com/how_2006650_invest-triple-tax.html
5. http://www.prudential.com/view/page/12608?param=12624

How to Avoid Common Investment Mistakes

"Zut alors" echoes the investing disenchantment, "not again". Avoiding the mantra of common investment mistakes, and while we are on the topic, common financial advice, can cost money and are therefore ideally taken with a little thought.

The first step in avoiding common investment mistakes is to leap into a new way of thinking about your investments and then look at your past investing from that perspective. The reason being, if you look at investments with the same reasoning every time, you're likely to get similar if not the same solutions every time as well. What good is that if the standard investment advice yields lethargic results? Keep reading to find out.

According to the CFA Institute, an organization that certifies financial professionals, there are several common investment errors some of which include poor strategy, too many investment expenses, high investment turnover, and inadequate buying and selling habits. (cfainstitute.org). These investment mistakes are important and should be avoided but what they are not is individual specific. Standard investment advice often leads to standard investment results. So, in light of this, the first investment mistake discussed here will be tuning into financial gurus too much.

• Financial guru syndrome

Financial guru syndrome is the ongoing belief in the steady stream of re-wrapped investment terminology, information and reasoning. Financial gurus be they hedge fund managers, Chief Executive Officers of Banks, or mainstream economists may be wise, learned, and have a lot of experience and know how within the financial sphere but what they are most definitely not, is you, the individual investor. In the media, financial gurus speak to the masses not to the individual and who is more important than you when it comes to investing. Get it? The same advice for Mr. A may also apply to Mr. B, but that doesn't mean it applies to Mr. B's investments in the way Mr. B wants it to.

• Mono-economic financial planning

Another technique to consider when avoiding investment mistakes is dual economic financial planning. If this sounds confusing don't be fooled because it's not. Dual economic financial planning involves investing for both good and bad economic times. Many investors choose conservative investments so they can withstand poor market performance, but that only goes half way in investing for dual economies. Taking investing to the next level, and rethinking investments for all scenarios is a useful step in avoiding the common investment mistake of ignoring down markets. By investing for both up and down markets one is not merely hedging bets, but banking on the good and the bad.

• Rewriting investment history

Ever get the feeling your "new investment strategy" isn't quite as new as it should be? If yes, you could be rewriting investment history. Consider an investor who is within 5 years of retirement and has just lost 25% of retirement net worth. Using a retain worth conservative pre-retirement strategy is useful and not to be underestimated, however, this doesn't solve the problem of weak past investment performance or loss.

One way to approach this particular investment situation would be for the investor to realize not all that money will be needed in the first few years of retirement. That opens the door to a longer term investment horizon within which the investor can regain and potentially increase his or retirement funding. Overused financial strategies can lead to a rewriting of investment history. If you want to avoid that mistake, improve your approach to investing.

• Tubular dollar vision

Tubular dollar vision is essentially the same as financial tunnel vision, and financial tunnel vision can be harmful to your financial health. By not rethinking investment strategy and technique in a new way, with new goals reduces the possibility of enhanced investment performance. For example, Mrs. Y has done reasonably well and achieved an individual average ROI of 12% after investment taxes and expenses.

Tubular dollar vision might say, that's good, keep on keeping on with that and the power of compounding and consistent ROI will leave you in good shape in such and such an amount of time. In Mrs. Y's case, tubular dollar vision might not be so debilitating, but this does not necessarily mean Mrs. Y is making the most of her money. To avoid tubular dollar vision, try a tri-kaleidoscopic frame of financial reference to avoid common investment mistakes and reach new financial attainments.

The Best High Risk Stocks to Buy

High-risk stocks to buy should ideally provide a high return on investment to compensate for the risk taken in the investment. High risk stocks to buy include stocks listed in pink sheets that are traded in the Over The Counter Bulletin Board (OTCBB), micro-cap, private stock, small cap and some mid-large cap stocks.

In fact, any stock has the potential to be high risk, but some have a greater chance at being bad risks than others. Deciding which high-risk stocks to buy involves first defining what high risk is, and then determining why the risk should be taken. In other words, understanding how to differentiate between good high-risk stocks and bad high-risk stocks may assist in selecting the best high-risk stocks to buy.

What a high risk stock is

High-risk stocks are the shares of high-risk companies. In some cases trading activity of a stock may influence its risk, however for the most part high-risk shares stem from the company itself. High risk generally means the stock price as well as the company shareholders own has a higher than average risk of failure, hence increasing the risk of share prices dropping.

This makes the term 'best high risk stocks' seem a little paradoxical because some people associate risk with bad, in which case there are no 'best high risk stocks' to buy. The following list comprises some of the characteristics that may indicate a high-risk stock.

• Volatile price movements
• Under capitalized
• New businesses
• Badly managed
• Weak performing industry
• Overbought shares
• Unregistered and/or less regulated



How to identify a good high risk stock

Believe it or not some high-risk stocks may be quite a good investment. Just as businesses and financial institutions use risk management, individual investors can manage their risk by distinguishing between reasonable and low-profit probability stocks within the same high risk category. The trick is knowing which stocks are merely high-risk by classification and not actuality. For example, investor models, analysts and trading tools may all indicate a particular stock is high risk due to the potential for failure.

This does not mean the company will fail however, just that the probability of it failing is higher. To find a good high-risk stock involves knowing what to look for. For example, a company with all the characteristics of a high-risk stock may also be a good high-risk stock for the following reasons.

• High growth industry
• Strong quarterly reports
• Innovative technology, product, service etc.
• In demand i.e. non-saturated market
• Competitive edge
• Good value

How to identify a bad high risk stock

Just as some stocks may be more likely to be the best high risk stocks to buy, some may also be the worst, or not as good. Distinguishing the best stocks from the worst is important in determining what aren't the best high risk stocks to buy actually are. For starters, inverse patterns to that of good stocks may indicate a bad stock in addition to characteristic variables that can correlate with the downward or declining value of a company's stock price. The items below may hamper and/or prevent a high-risk stock from risking in price over time.

• Stagnant or declining industry
• Non-growth orientated
• Inefficient operations
• Conflicted organizational structure
• Non-distinguished product and/or service
• Over valuation of shares

Stock and risk analysis

No one can predict which stocks are the best with 100% accuracy, but one can identify, distinguish and differentiate some probability of stock success within the high risk category. This probability can be ascertained both quantitatively and qualitatively with a review of specific areas of performance. However, obtaining the correct information is a challenge in and of itself, especially with private and non-SEC registered corporations.

In light of this, being weary of conflicting and competing information can at times, be difficult when determining a particular stock's chance of success, be it in regard to short-term, medium-term or long-term performance The list below illustrates some of the factors and tools that can be used in analyzing a company's stock.

• Statistical data sets
• Financial fundamentals
• Technical performance
• Economics
• Strategic plan
• Operational and organizational structure
• Managerial accounting

Consideration of a high-risk stock's performance may involve additional techniques of risk analysis. For example stocks within the high-risk category may vary in risk levels based on things like the cost conversion cycle, project management, consistency of revenue, affect of business cycle on the company's solvency, debt management etc. There are many ways to review and study a company's performance that makes accurately determining a company's risk more difficult than it might sound. Nevertheless, with enough knowledge about a business, its competitors, the industry etc. an investor may have a better chances at selecting the best high risk stocks to buy.

Dollar cost averaging: How this simple investing strategy can help your money grow

Dollar cost averaging is an investment strategy that can help lower investment risk by spreading out investment over time. While dollar cost averaging can be beneficial at times, it does not guarantee investment success because the value of the investment can continue to decline despite averaging down. Nevertheless, dollar cost averaging is a commonly used investment technique that is used both knowingly and unknowingly by participants in retirement plans, and is also used by financial management companies.

How to dollar cost average

To dollar cost average one essentially spreads out one's investment in a particular financial instrument over time with a number of fixed or variable payments. For example, if one participates in a managed retirement plan such as an IRA or a 401K, monthly contributions may be made into various investment products as per agreement with one's financial planner.

In such an instance the money is invested in pre-selected investment products regardless of their value. Since some product such as mutual funds or exchange treaded funds can and do fluctuate in value, ones investment will be distributed over a range of prices with each scheduled payment. Thus, in the case of a mutual fund, it will be purchased on a staggered basis over time, sometimes at higher prices and other times lower. After time, one accumulates value at an averaged price since the mutual fund is being bought at multiple prices.

To illustrate, suppose one has a life insurance policy that contributes a portion of the monthly premium into a mutual fund or group of mutual funds. If the monthly premium is $100.00 and 75% of the premium is applied to 3 mutual funds, then every month $25 dollars will be applied to the purchasing of those mutual funds by the mutual fund manager and/or life insurance policy.

If the prices of each of the funds are $12.50, $25.00 and $32 respectively at the time of the first premium application then the $75 will purchase 2 shares of the first fund, 1 share of the second and .78 of the third. If in the second month, the prices of the mutual funds change to $11.25, $27, and $30 then the next installment will purchase 2.22 of the first fund, .93 of the second and .83 of the third.

Advantage of dollar cost averaging

There are several advantages to using dollar cost averaging as an investment strategy. These advantages can be particularly useful over long periods of time is the investment product is well managed and performs well over time. Some of the advantages of dollar cost averaging are listed as follows:

• Evens out price risk
• Allows the potential to purchase more value for the dollar
• Facilitates more regular and manageable cash flow
• Can be a beneficial strategy for long-term investments

Disadvantages of dollar cost averaging

Despite the clear advantages of dollar cost averaging it is generally not a perfect or flawless investment strategy in and of itself. For this reason it can be wise to consider the disadvantages as well as the advantages when thinking about using this strategy. Some of the disadvantages of dollar cost averaging are noted below:

• May not add value in the case of a bad investment
• Has the potential to lower value of ownership if investment product consistently rises in value
• Can increase risk if only one investment product is invested in
• Benefits may not be realized if not used in tandem with other investment strategies

Dollar cost averaging is an investment strategy that has been in practice for a significant time. It is based on the mathematical principle of averaging, and can be applied to a number of different investment products and is consequently a flexible investment strategy. Dollar cost averaging has several potential advantages that may contribute to lowering risk and expanding investment success over the long run.

However, if a short run investment strategy is used and/or investment product prices do not decline then the cost of investment will rise more than had the full investment amount been applied at the beginning of the price rise. In other words, there are also disadvantages to using the dollar cost averaging method.