A Small Cap Stock is a stock with a market capitalization (market cap) anywhere between $500 million and $2 billion. Market capitalization is the total value of a company and represents the size of a company.

Market cap is calculated by multiplying the number of shares outstanding by the price per share. Theoretically, this is the amount of money you would need if you wanted to buy the entire company (plus any takeover premium).

Stocks are typically divided into three main categories based on market cap:
Large Cap= $8 billion and above
Mid Cap= $2 to $8 billion
Small cap= $500 million to $2 billion

By looking at a stock's market cap, you can quickly make a few generalizations.
In addition to size, large cap stocks tend to be solid companies that have been around for a while and are typically stable, have lower volatility, involve less risk, and are considered more value oriented.

Large cap stocks are also less sensitive to minor fluctuations in the market climate, such as the news or current events. They may experience periods of growth with new products and services, but are usually considered stable investments.

Small cap stocks have the potential for high growth in a short period of time, which makes them desirable to investors and traders.

Small cap stocks tend to be emerging companies that have not been around very long, but may offer a greater deal of growth over value. A small and newer company has more room to grow and could become a heavyweight blue chip in the future. Finding these hidden gems is a challenge, but the rewards may be greater.

Growth, Volatility, Risk
While the rewards may be greater, the losses may also be greater. There is a direct relationship between growth potential of a stock and the amount of volatility and risk involved. Typically, growth oriented investments, like small caps, are coupled with higher volatility and higher risk.

HINT: Volatility is not necessarily bad. It indicates the potential for profit, but with associated risk.

Diversification: Lessen the Risk
There are a few ways to mitigate the risk associated with investing in small cap stocks. One way is to diversify your portfolio by having a variety of different stocks with different market caps. This spreads out your risk across an assortment of investments. Add some bonds, commodities, and options to round out your portfolio.

Mutual Funds
Mutual funds are investment vehicles that contain a variety of stocks, bonds, and commodities. Essentially, a mutual fund has done the diversification for you.

Each fund varies in terms of investment objectives, such as value oriented, growth oriented or blended. Mutual funds are managed by professionals to ensure the appropriate balance of risk and growth is achieved within the fund. By investing in different asset classes, losses in one area are offset by gains in another and profits are achieved over the long term.

Options As a Hedge
Purchasing put options as a hedge is another method of portfolio protection should the market take a sudden downward turn. This concept is similar to having insurance' on your investment. The idea is to secure the right to sell your stocks at a specific price should the stock price drop. A put option increases in value as the stock price drops. This provides the investor a way to sell the stock without a loss or only a minimal loss.