Thursday, May 10, 2007

Investor’s Beware: Wide Bid/Ask Spreads and Market Orders are a Dangerous Combination
As investors, we love to see our stocks heading up (if we are long, that is). I was pleased on 5/1 to see tiny, sometimes troubled, and always mysterious historic document provider Gallery of History (HIST) spike upward about 30%. About time I thought. Finally, the market is catching on to the story: A company that will never make any money, whose major shareholder has not done the company any favors, but whose inventory of historic documents may be worth substantially more than the company’s enterprise value, let alone carrying value.

Upon further inspection, however, this 30% spike actually represented one single 100 share trade. Subsequently, the bid/ask spread headed downward significantly, and it was clear that the price spike was a phantom, created by an eager investor who placed a market order on an illiquid security. Never a wise course of action.

A company such as HIST, with a tiny market cap of $11.5 million, average daily volume of just 2000 shares, and most recent bid/ask spread of 1.91/2.19 is a poster child for one of the small investor’s best friends, the limit order. Placing a market order in a security with such tiny volume, and large spread will just set up the unsuspecting investor for disaster. Who wants to purchase a stock worth $2.00 for $2.75, only to see the next trade at $2.00? And it happens more often than you might imagine.

So, our unknown buyer of 100 overpriced shares of HIST is automatically out 30% of his or her money, granted, that’s less than 50 bucks in this case. But what if that order had been for 1000 shares or 5000 shares? Illiquid security buyers beware. Use limit orders, be aware of bid/ask spreads, be cognizant of the average daily trading volume, and how large your intended trade is compared to average volume. If you set a limit order, and the order is not filled at your price, either try again another day, or reevaluate what you want to pay for the stock.

*The author has a position in HIST. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

No comments: