In the stock market, almost all stocks fit into three categories; large cap, mid cap and small cap stock. There are other categories like micro cap stocks or mega cap stocks but there is no standard rule and most will fall into the big three categories. Specifically, small cap stocks are usually considered to be any company whose market capitalization is somewhere between $300 million and $2 billion. This is not an exact definition and varies from one investor or brokerage house to another, but you get the idea of what people are referring to when they talk about small cap.

The small cap companies may be in the situation that they are for many reasons. It might be that they are a recent start-up or that they are a once large company that is in the stages of winding down because they have become obsolete or did not change with the times.

These small cap stocks have both advantages and drawbacks to them. Looking at the drawbacks first, they are not necessarily proven companies, and without the capital that a large blue chip company would have they do not always have the means to change direction if they see an opening in a market. As smaller companies, if the operations fail there is not as much of a safety net that is the ability to liquidate and suffer a loss. Often a loss of market share can end up being more catastrophic for a small company than a large one.

On the advantage side they have growth potential. If you consider the companies that were once small cap you will see just how much potential. There are a few Microsoft millionaires out there, and for those people who got in early they saw their stock increase in value in numbers that are hard to believe. In recent years there have been big winners as well. When you look back on what has happened in the last decade it seems to be perfectly obvious why some companies rose to the top but they were just unknown small cap stocks at one point. Look at companies like Research in Motion. The blackberry is well known now but it wasn’t always that way. If you see a company that has a product that seems like everyone will want one that is the kind of small cap company that you want to invest in. Ideas and the patents that protect them are often the strongest assets that these companies have.