It is difficult to identify a speculative stock as we get trapped in calculative trading or circular trading under-taken by a group of persons. Here are a few characteristics that can help an investor identify speculative stocks or stay away from such traps.
Size of the company
Speculations can happen irrespective of the size of the company. However in most cases, it is the small or mid-cap companies that attract the attention of traders. This is possible given the low liquidity, which allows traders to corner certain shares and rig prices.
In case of small-cap companies too traders can corner the shares and keep the supply under control, as there are few shares and less investor. It is difficult to do the same in case of large companies as they have large floating stocks in the market and huge number of investors. Investors should, therefore, be wary of small and mid-cap stocks.
Trading volumes
Pattern of volumes is important because it gives an idea as to why more people have suddenly developed interest in a particular stock. There are cases where daily volumes have gone up to 10,000 shares from 1,000 shares and further to 5,00,000 shares in a very short period. Here one can look at the delivery volumes taking place in that particular stock to understand if they are just hollow trades. It is almost certain that speculative stocks come along with the sudden spurt in volumes, which bring higher prices to attract more and more investors, particularly retail investors.
News flow
When volumes and prices gain momentum, a stock comes into the limelight and news or rumours about possible acquisition, land bank, merger, takeover, open offer, listing of a subsidiary company, restructuring, new orders, etc begin circulating. In many cases it is possible that not only traders but also insiders or the company staff or the management is involved in such calculated trades. Such news and rumours are spread to take the stock higher and higher. In most cases, the management is candid about its plans initially.
But when share prices reach their desired levels, the management appears on TV, newspapers and sometimes they even start advertising about the company and their plans, only to attract more investors. Remember news always comes in the end when the original traders who bought the stock at peanuts want to exit with hefty returns at the cost of others who now invest. A saying in the market goes thus: "Buy the rumour, sell the fact." The run up in share prices ends as soon as the company makes the official announcement.
Source: http://www.nirmalbang.com/Research/BeyondMarket.aspx?id=31&type
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