How to Trade in Illiquid Microcaps
Because paying 3% more than you should isn't a strategy
Many of you already know how to trade illiquid microcaps. If that’s you, consider this a refresher. But if you’re newer to buying and selling thinly traded names, it’s worth learning the basics.
This part of the process matters more than it seems. In low-volume stocks, poor execution can cost you multiple percentage points per trade. Done poorly and repeatedly, it can drag your returns down by 5 to 10 percentage points a year.
This is an introductory practical guide to trading microcaps in a way that protects your capital and keeps execution costs under control.
Think in Volume Terms
When you're trading illiquid stocks, the first thing to look at is how much volume trades each day. That sets the boundaries for what you can realistically move, both going in and coming out.
As a rule of thumb, I try to keep my trading under 25% of the average daily volume. It’s not a hard cap, if fills are coming easily and I’m watching it closely, I might stretch it, but 25% is the upper number I use when planning trades. If a stock trades $20K a day, I’m typically planning to keep my order size under $5K per day. Starting out you probably want to set your upper number to 10% at the most when planning.
The reason is simple: once your order becomes too large relative to natural volume, you start moving the price against yourself. On the buy side, that means worse entries. On the sell side, it can mean trying to unload into a vacuum. Staying under that threshold helps avoid both problems.
Limit Orders or Nothing
In illiquid stocks, I never use market orders. The spreads can be wide, and the depth is usually thin. One bad fill can blow up your entry price.
I always use limit orders and usually start with a bid below the current price. If nothing hits, I’ll raise it slightly a few hours later or the next day. Sometimes it takes a few days to get any size filled, and that’s fine. Take your time.
Every once in a while, a name will run away from you. That happens. But most of the time, waiting works better than chasing. You’re playing probabilities here. A slow, patient approach tends to result in better entries and fewer regrets.
I’d rather spend a week accumulating than pay up 3% for instant gratification. That 3% difference is the kind of thing that compounds over time.
Let the Stock Come to You
Some limit orders won’t fill right away. If there’s no action, or the price drifts slightly above your bid, there’s no reason to react quickly.
The goal is to enter at a price that makes sense, not just to get the trade done. If you’re not seeing volume where you want it, leave the order in place or adjust gradually. You want to be sitting back and letting the stock come to you.
The worst fills tend to come from impatience. Thin names are especially unforgiving when you start competing for price. Staying passive keeps you from becoming the reason your own cost basis gets worse.
This is one of the few areas in life where being lazy gets better results. Be slow and lazy when buying and selling. Keep your order just outside the active range and let the volume come to you.
Algorithmic Orders
If I’m building a larger position, I’ll sometimes use an algorithmic order to break the trade into smaller pieces and spread it out over time. These tools usually try to track market volume or follow order book activity so you’re not dumping everything into a thin tape.
They can be helpful, but only if you understand how they work. Different brokers use different pacing logic, and some algos behave aggressively while others do almost nothing unless nudged. Before using one, check with your broker or look it up. ChatGPT can usually walk you through the basics of how a specific algo functions.
Algos are great until they aren’t. Like cruise control off a cliff. These aren’t set-and-forget tools, you still need to watch them. Back in 2013, I had one push a stock up over 15% before I caught it. It turned out to be a software bug, which was more common back then when these systems were newer. (It was slightly amusing watching everyone on the forums try to explain the spike that day. Nobody knew it was just my algo losing its mind. So much for market efficiency.) That hasn’t happened since, and platforms have improved a lot since then. Still, if there’s real money on the line, your eyes are an essential part of the risk management process.
Broker Limitations
Some brokers restrict trading in low-liquidity stocks. They treat illiquid stocks like they’re trying to protect you from yourself, which covers them legally but is completely unhelpful. They’ll block certain order types or prevent you from trading specific names entirely. That can be a problem if you’re focused on microcaps.
I use Interactive Brokers because their execution tools are good. But they do limit access to a few names I want to trade, and their customer service is usually abysmal. I would rather have the good execution but there are times when I wonder if it’s worth it.
You’ll also want to check whether your broker sells order flow. Most major retail brokers route trades through wholesalers like Citadel in exchange for payment. That arrangement can delay fills or result in worse pricing, especially when you’re trading low-volume names where every tick matters. Some brokers don’t give you a choice, but others allow manual routing and don’t sell your order flow. Worth looking into.
If you’re serious about execution, this matters. You want your orders going to the best market, not to whoever paid for them.
Whatever platform you use, make sure it lets you access illiquid names and doesn’t interfere with your ability to trade the way you need to.
Patience Is Part of the Strategy
If you need instant feedback or fast fills, this isn’t your game. Trading illiquid stocks means dealing with open orders, partial fills, and waiting. Some of my best positions took weeks to build, occasionally over a month. I’d add a little each day, sometimes with no action at all for days at a time. I once heard Jason Hirschman say that he entered trades like an old man getting into the bath, it isn’t fast and it isn’t pretty. Jason knows what he’s doing.
If you’re used to buying what is talked about on CNBC this kind of timeline might drive you nuts at first, but you’ll get used to it… maybe even learn to enjoy it. It’s part of what creates the opportunity. The people who can’t handle it leave room for the ones who can.
If you stay patient and work your plan, you’ll usually get filled, and very often at better prices than if you’d chased. In thin markets, the advantage goes to the patient.
I will get into more details on trading execution in a future post but for now the goal is to make sure you aren’t lighting 2-3% on fire just getting in.
Coming soon
I’ve found two names that look particularly interesting (but are pretty small) that I will likely be highlighting soon. I’m also working on a few posts for those interested in building their own ranking systems. I’ll be walking through some of the factors I use and how I approach the quantitative side. If that’s something that’s interesting to you, make sure you’re subscribed.