Falling liquidity in small cap and mid cap stocks

2008 has been an extremely volatile year for the equity markets. Along with market fluctuations, there has been a fall in the liquidity for individual scripts. This is more pronounced in the case of mid cap and small cap companies.

The Bombay Stock Exchange (BSE) has seen a fall in the turnover in both cash and equity segments. This has hit small investors hard as often small companies are listed only on the BSE and not on the National Stock Exchange (NSE). For several companies the turnover is below thousand shares a day, making it difficult to buy/sell even small quantities.

This hits small investors the hardest. Large investors like mutual funds, insurance companies, FII’s tend to stick to the large companies anyways. Small investors typically seek value in smaller companies and here they are facing a liquidity crunch.

While purchasing shares of a company, the liquidity has always been a criterion. In the current market scenario, it gains more importance, and small investors are advised to keep away from shares with very low liquidity. Typically, shares in the A group have more liquidity and they could form the first sub set from which companies are picked out.

While picking stocks outside the A group, the following guideline could be typically used – An investor should be able to buy/sell shares worth at least Rs 25,000 in that company without difficulties in the day. It is important to have a benchmark in terms of value as the market price of the share might vary from Rs 2 to Rs 10,000.

In a nutshell, ideally consider shares which are traded both on the NSE and BSE and have atleast a minimal level of liquidity, so that we can buy/sell them without having to pay a liquidity premium.