The stock market has seen a lot of growth in the past few years, as the Federal Reserve kept interest rates low. The industry also important growth because of the concept of Special Purpose Acquisition Companies (SPAC), which made it possible to go public without making any disclosures.
In this article, we will highlight the different types of stocks and how to trade them.
Types of stocks by size
Publicly-traded companies come in all sizes. And these sizes can determine how one can trade them well. Ideally, stocks can be categorized into the following classes.
First, there are penny stocks, which are extremely small companies whose stocks trade at less than $5. In most cases, these penny stocks are small firms that have a market cap of less than $100 million.
Some penny stocks go public when they are small companies. Others become penny stocks when their share prices decline sharply in a short or long period of time.
A good example of a company that became a penny stock is Blue Apron, whose share price collapsed from almost $150 to about $3.
Penny stocks are known for their volatility, insider trading, and pump and dump schemes. These companies are also not followed by many Wall Street firms. As such, it is a bit difficult to analyze them from a fundamental value. Another notable thing is that they tend to have low liquidity.
These are companies that have an extremely small market capitalization. In most cases, it refers to companies that are valued between $100 million and $1 billion.
Examples of these companies are WW International, Canoo, and Ethan Allen among others. These firms tend to have average liquidity and some are even followed by Wall Street analysts.
These are companies that are slightly above small-cap firms. Indeed, most companies listed in the US are in this category. It is used to refer to companies that have a market cap of between $1 billion and $10 billion.
Examples of these companies are Digital Ocean, Realogy, Appfolio, and Travel + Leisure. These companies have deep liquidity and are closely tracked by Wall Street analysts.
» Related: Market Liquidity Matters!
These are large companies that have a market cap of between $10 billion and $100 billion. In the past, most big companies belonged to this group.
Examples of these firms are Pioneer Natural Resources, Hubspot, Monster Average, and Cognizant.
» Related: How to trade large cap and small cap stocks
These are large companies that are valued at more than $100 billion. The number of these firms has been in a strong growth. They include companies like Apple, Microsoft, and PayPal.
In general, looking at companies by size will help you substantially. For example, if you have a small account, it makes sense to trade small and penny stocks that have a small share price.
For one, if you have a $500 account, it will not make sense to trade a stock like Berkshire Hathaway that trades at over $500,000.
Types of companies by industry
The United States has a highly diversified economy. It is unlike countries like Saudi Arabia which have a relatively singular economy. Therefore, the American stock market has companies in various sectors. As you will find that companies in different sectors have different characteristics. Some of the top categories are:
- Technology - These are firms that have a tech element. For example, Netflix is a tech company because it provides video content using the internet. Tech firms have faster growth and have a premium valuation metric.
- Consumer staples - These are companies that provide products that are needed by people for survival. Examples are firms like Unilever and Clorox.
- Consumer discretionary - These are firms that provide products that are wanted and not necessarily needed. Examples are firms like LVMH and Revlon.
- Finance - These are companies that are in the broad financial industry. They include firms like banks and insurance companies.
- Energy - These are firms that provide energy solutions such as oil and gas and solar panels.
- Utilities - These are companies that provide products and services that are needed by people like electricity and water.
Trading companies by type
Ideally, the process of trading companies regardless of their size is the same. At DTTW™, we recommend that traders should focus on three important approaches.
First, there is the fundamental aspect, where you open a trade depending on the current events of the firm.
These fundamental aspects include the latest news, valuations, earnings, and inflows and outflows (but there are others that matter). A good example of this is shown in the chart below where the Teladoc share price crashed by 50% after it published weak earnings.
Second, there is the concept of technical analysis, which involves focusing on chart patterns and technical indicators. Examples of leading technical indicators are moving averages, relative strength index (RSI), and Bollinger Bands.
By adding these indicators in a chart, you will be at a good position to identify whether a stock will go up or keep falling.
Finally, there is the idea of price action, which involves looking at candlestick and chart patterns without relying on any tool other than your own eye.
Examples of leading candlestick patterns are bullish and bearish engulfing, harami, and evening star. On the other hand, chart patterns include triangles, wedges, and rectangles.
» Related: The Best Reversal Patterns for Day Trading
In this article, we have looked at some of the most important aspects of trading stocks by their specific types. As a trader, you just need to know the types of stocks that you are dealing with.
Also, it is important that you know the three types of trading analysis that we have looked at in this article.
External useful resources
- What are different types of stocks? - KotakSecurities