Friday, October 05, 2007

Trading Illiquid Stocks

By now you know that some of the companies we cover at Cheap Stocks are thinly, or in some cases, rarely traded, and this brings with it a whole host of challenges and risks. These include difficulty in establishing, and exiting positions.

We recently closed a position in such a company, Bactolac Pharmaceuticals BTCP), and thought it would be both interesting and informative to detail the process, and results.

We initially purchased Bactolac(BTCP)when it was known as Advanced Nutraceuticals(ANII), and prior to the company's 1 for 500 split, so liquidity was not an issue in establishing the position. Howewer, post split, there were less than 9000 shares outstanding, and little, if any trading.

When we decided to close the position, the bid/ask was $1400/$1700. (One place to find this information is the Pink Sheets Website; which we recommend checking before you check with your online broker).
Although we were content to exit at $1400/share, we decided to to place a limit order at a higher price. It took 3 days, and 4 different orders to finally close our position:

Day 1: Placed limit order at $1600/share
Result: Order was not filled

Day 2: Placed limit order at $1550/share
Result: Order was not filled

Day 3: Placed limit order at $1500/share
Result: Order was not filled
Changed order to limit $1425
Result: Order was filled at $1450/share

The point is that there are risks in trading illiquid stocks.
1. Be very careful not to place market orders, because you may end up establishing a position at a much higher price than you intend.

2. Don't purchase illiquid stocks unless you can hold for an extended period of time. Being a panic seller here can and will be extremely costly.

3. When you decide to sell, be aware of the bid/ask prices. Don't place market orders, and be aware that if you do place a limit order, there is no guarantee that your entire order will be filled.

4. In general, don't allocate too much of your portfolio to illiquid stocks. We believe there are some great opportunities out there, but you should limit this to a small percentage of your portfolio.

*The author does not have a position in Bactolac Pharmaceuticals. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

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