January is here. We’ve already seen the largest first-week rally since 2003, and then the inevitable collapse with the release of tough economic numbers. In one week, the Dow has picked up and lost 300 points as if it was a New Year’s resolution diet.

But the most important piece of news for small-cap investors thus far has been overlooked…liquidity is returning to the market.

My colleague Greg Guenthner summed it up best the other day: “FINALLY, people are buying stocks again!”

We have battled low volume for months now. There was simply no one trading. In this economy, it’s understandable. It’s a common reaction to get rid of as much as you can and hold onto the rest as tightly as possible. Unfortunately, that’s not how people make money.

As Greg put it to his Bulletin Board Elite readers back in November, “Stock prices will not line up with a company’s performance. With high volatility and low trading volume on the bulletin boards, this just isn’t going to happen right now.”

The massive sell-off, followed by this severe liquidity drought, has given small-cap investors the largest headache over the past few months.

No one likes to lose money or see investments lose 40% of their value. But small-cap traders can handle it. After all, who cares if a few of your stocks fall a bit if you also own some multipliers? A single 300% gain wipes out a dozen losers.

The problem isn’t whether or not you lose money on some investments. The problem is whether you can invest at all. As Greg was referring to above, small caps — especially those on the bulletin boards — have completely seized up. No trading means no gains. If no one is willing to buy your stake of a company, you can’t cash in on any profits you might be holding.

We’ve stared at stock charts for hours and wished volume would pick up so we could recommend certain companies. As frustrating as it’s been, nothing compares with what it’s like to see so many insane bargains left untouched. Without volume, it doesn’t matter if a $20 company is trading for $3. We just can’t touch it without buyers and sellers.

The bulletin board volume has been even worse. I’ll use an example from Greg’s Bulletin Board Elite service. One of his companies jumped from 16 cents to 32 cents on a single 2,000-share trade Wednesday morning. By yesterday morning, that same company fell back to 25 cents on another 2,000-share trade. That’s a 100% gain followed by a 22% fall on a little over $1,000 worth of trading.

While we may not be back to full volume capacity yet, this is still an improvement from the last two months of 2008. There were six full days in November and December (not including Thanksgiving and Christmas) when absolutely no shares of this company changed hands. There were many other days that only a few bucks worth of stock was traded.

We think this is the turning of the tide. Liquidity should continue to pick up, which will open up a brand-new stream of options for smart investors.

As volume continues to rush back into the market, small-cap investors must be ready to strike anytime. The market is starting to give us a chance to buy. You don’t want to miss it.

Sincerely,
Jim Nelson

January 9, 2009

Jim Nelson

Jim Nelson began his investing career during the tech boom at age 14 – with purchases of Starbucks and AOL. Early inspiration came from an old Tweedy Brown whitepaper: “What Works in the Market.” He graduated with a degree in Political Science from Pittsburgh University, Nelson focuses on income investing, including dividends, covered calls, and fixed-income. Additionally, he covers MLPs, ADRs, utilities, consumer staples and tobacco. Nelson is the managing editor of Lifetime Income Report.

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