You may have heard many traders say that large cap stocks are not a category that should consistently be traded. There are a number of reasons (some legitimate) that a trader may shy away from large cap stocks. These include:
- Not enough volatility (especially in dividend paying large cap stocks)
- Too crowded (there are too many algorithms and too much “smart money” transacting already)
- Too much risk of a mutual fund or hedge fund with large orders changing the trade out of nowhere.
- Too many competing interests for them to ever have a consistently readable direction (in the short run)
- The price is already very efficient.
These are the most commonly cited reasons that day traders stay away from large cap stocks during the course of their trading. While these are all real concerns every asset class has its own set of difficulties. Like anything, the answer to whether or not you should trade large cap stocks depends upon your goals and strategy. Here are some times and reasons to justify when it may behoove a trader to dip into the large cap lake.
Recap, What A Large Cap Stock Is
A large cap stock is one of the largest stocks traded in the marketplace. Large cap is short for large capitalization (refering to the size of the market capitalization, or total value of all outstanding stock). For a stock to be considered large cap is must have a total market capitalization of more than $10 Billion dollars. Large cap stocks are mostly extremely well known companies such as Apple, Exxon Mobil, Proctor and Gamble, General Electric, Walmart, and Microsoft. Many large cap stocks are also “Blue Chip Stocks”, which refer to large financially strong companies that have been around for a very long time. Many blue chip stocks operate in manufacturing and consumer goods.
Now that you are clear what is meant by large cap stock, here are times when it can be profitable to trade them.
Your Strategy Doesn’t Depend Upon Large Fluctuations
Many large cap stocks do not experience a lot of volatility (as a percentage of their price) on a day to day basis, which can make them a difficult trade for some day traders who need a stock to make significant moves. This would be true of a trader who has a standard brokerage account and only trades with their own capital, buying and selling equities. There are many other ways for a trader to make money today.
Many day trading strategies do not need large fluctuations (in percentage terms) in order to be profitable. A prime example of this would be a binary options trader. In binary options, the trader only needs to end up “in the money”, even if only 1 cent, for the trade to pay out the pre-determined amount. The payout to him is the same regardless of the percent gain in the position. A binary options trader depends upon reliability much more than large movement.
Another strategy that may not need large moves in the price of the stock is if the trader is using large amounts of leverage. For instance if a trader is a proprietary trader trading for a brokerage. When a trader uses the house leverage in large quantities, their positions may be so large that even a movement of a few pennies can bring them large gains.
Another strategy that may not require large movements in price is a strategy involving stock options. Some people buy short term call or put options, and even a small movement in the stock’s price may correspond with a large fluctuation in the price of the option. Other people “write” option contracts. If a day trader writes an option contract, he is betting that the price will either stay the same or move in the opposite direction (down if he writes a call or up if he writes a put) from the direction the buyer would like the price to move. Someone who writes an option contract is creating a contract, and if that contract expires out of the money the trader does not need to deliver any shares of the stock at expiration (and their profit is the value of the option they sold).
If you do not need large movements in a stocks price, large cap stocks may be the trade for you. Reliability may be more important that size of price changes.
The Price Action Is Readable
If you do not need large price fluctuations but instead depend upon a stock being reliability, many large cap stocks will go through periods when their price action is especially readable. The dependability of the trade may be very attractive. These are examples of when (and how) a large cap stock may become a reliable trade.
- Many algorithms (or traders) appear to be buying or selling at the same time (when the stock reaches a particular price, RSI, or moving average for example). While this will never always hold true, it may hold true long enough or often enough for a day trader to turn some serious profits.
- The largest transactors in the stock may be mostly buying and selling (moving the price) in the same way on a particular day. This may be a result of news, industry changes, or re balancing of their large portfolios (usually takes place at the end of quarters). If the price direction for a day is very readable and the large transactors appear to be moving the stock in the same direction, it may be a trade to consider. Usually large transactors can be “sniffed out” by reading the prints.
- A stock is either “hot” or mired in dismal performance. You may notice that a large cap stock appears to have increasingly worse and worse prospects, or a particular stock may be in the news a lot and may be generating more and more profits such as Apple (AAPL) has been doing for years. If you notice a real trend that you want to be a part of, large cap stocks often have long term trends that stay true for enough time to profit from a trade.
You May Want To Play Earnings
Earnings are an especially volatile time for a stock. Many times even a large cap stock stock can move 5%, 10%, even 20% after earnings are released. Because large cap stocks are stocks that consumers may have more knowledge about, and they may have a lot more news/analysis coverage, many day traders want to take part in the earnings trade. If you think that you have a feel that earnings may be better or worse than the street is anticipating, or what is priced into the stock already, this can be a very exciting trade to be a part of. Just be careful, as earnings release trades can move a stock’s price a lot for the better but it can also move the price a lot for the worse (depending upon the direction of your position).
Large Cap Stocks Are Still Good To Trade
You do not need to fear large cap stocks as a day trader. What is most important is that you recognize when they can be traded, and that they are most valuable either when your strategy depends upon their reliability or you do not need large price moves in order to be highly profitable. If you can develop a profitable trade in a large cap stock, you should work to exploit it to it’s fullest potential, as day traders make the most money when they are creative and aggressive in their trading.